When it comes to risks in the Chinese economy and capital markets, investors have been fixated on a mindset since the beginning of the year that stabilization would take priority before the 19th Party Congress, with policies supporting economic growth and stock market rally. Let alone debating whether such mindset is well grounded, it becomes imminent to revisit investment strategies as the 19th Party Congress takes place on October 18.
The Party Congress’ agenda traditionally focuses on the election of Central Committee members rather than specific economic policies. Hence we do not think there will be a drastic change in the direction of the current policies and reforms. In light of recent performance of the equity market and the economy, our general view on China is that investors should shift the focus of their investment strategy from pro-growth policies to structural reforms.
Year-to-date economic growth in China has already surpassed the 6.5 percent GDP target set at the beginning of the year. In the first eight months of 2017, the industrial sector posted robust year-on-year profit growth of 21.6 percent; exports have also improved significantly over the same period, from a 7.7 percent drop last year to a 7.6 percent expansion this year. This not only reflects the effectiveness of domestic policies such as supply-side reforms as well as the synchronized recovery in global economy, but also gives room to tune down economic growth targets post-Party Congress.
We expect that improving the economic quality and lowering the financial systemic risk will be policymakers’ key objectives in the coming quarters. In particular, rapid growth in the real estate sector has contributed to an increase of 10 trillion yuan in mortgage loans over the past two years, as well as an over 40 percent jump in land prices year-on-year. Under the current healthy economic environment, regulators have all the right to take the opportunity to prepare for potential risks.
On the investment front, they can curb developers’ land purchases through moderately tightening new loan issuance to increase their financing costs. From the sales perspective, they can prevent default risks by restricting home purchases financed by short-term consumer loans and other questionable means.
For the industrial sector, stringent execution of environmental policies and winding down of polluting capacities may sacrifice short-term GDP performance, but it is a crucial move to achieve long-term benefits for the ecosystem. We believe that such environmental policy will be extended to a wider range of sectors and regions after the 19th Party Congress.
In terms of the China equity market, we think investors should exercise caution during the Congress period and wait for the next wave of rally.
When it comes to global fund flows, we expect there will be more inbound investments looking for laggard value plays in the Chinese equity market, rather than simply chasing the outperformers. The RMB/USD appreciation since the start of the year has plateaued after mid-September, and the USD interest rate will be supported by the Fed’s balance sheet reduction and Trump’s tax reforms. These factors have curbed global investors’ risk appetite for Chinese equities in the near term.
If the post-Congress policy priority shifts to structural reform, investors may in the near term take profit from some of the Chinese property and technology plays, which have seen exceptional rally this year.
Meanwhile, the reform measures will effectively mitigate systemic risks and enhance financial asset quality, benefiting the financial sector and some of the state-owned enterprises. More importantly, the commitment of the new party and state leaders to China’s reforms will likely underpin equity market performance in the next year and the medium to long term.
In summary, the MSCI China index has risen close to 40 percent in the first three quarters of this year, far surpassing the 20 percent growth in Asia-Pacific equities and the 12 percent growth in US equities. Although the HSCEI index only reported a 17 percent increment this year, it has encompassed more value plays and we are therefore more optimistic on its future performance.
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