Chinese New Year: Policy in the Year of the Tiger

Gartmore's Charlie Awdry says China offers an impressive investment case over the next 12 months

China’s Year of the Ox has, appropriately enough, been a year of fortitude and patience.The Government’s economic stimulus was put to work and it has worked.

While economic growth dipped to 6.2% year on year in the first quarter of 2009, it had rebounded to 10.7% year on year by the final quarter. According to preliminary figures, growth for the full year was 8.7%. China overtook the US last year, to become the world’s largest market for cars, with estimated average sales of more than one million units a month.

China’s Year of the Golden Tiger begins within hours of the West celebrating St Valentine’s Day on 14 February. In Chinese culture, the tiger’s vivid stripes symbolise the balanced forces of yin and yang. It is perhaps appropriate the Government, while continuing to provide support for the consumer, has chosen this year to take steps to avoid the imbalances that can grow out of a credit bubble.

A concrete beginning

2010 and Year of the Tiger has started with the first concrete steps of tightening economic policy in China. This comes against a backdrop of an improving domestic economy, signs of improvement in the rest of the world and signs of over exuberance in some domestic asset markets, for example, trading volumes in Shanghai’s financial markets, which are higher now than at their peak in 2007, and the high price of Beijing property. A hike in the reserve requirement ratio for banks and strong words from the authorities are responses to the typical front-loading of lending by banks in the early stages of the year. As such, we see these as appropriate measures, akin to the authorities gradually taking their foot off the accelerator and we expect more through 2010. Consequently, this backdrop may make equity markets skittish.

Equally, it is worth saying the Government’s pro-growth tone appears not to have changed so we would not expect a tightening of policy that goes so far as to cut into China’s continuing economic expansion. Partly because China’s currency remains effectively pegged to the US dollar, exports have begun to grow again. In December, exports climbed 17.7% compared with the same month a year earlier, helping China overtake Germany to become the world’s largest exporter.

The pace of reform

China’s recent economic rebound should be viewed in the context of the country’s longer-term growth trajectory. The Government has accepted the use of economic activity, entrepreneurialism and capitalist forces to drive the economy and create jobs. The pace of economic reform has increased and, as the West has sought solutions to its financial crisis, China has continued to develop its own unique model of economic socialism.

China is now firmly entrenched as the world’s premier rising economic power. With around $2.3trn in foreign exchange reserves, China’s influence in Asia and around the world has risen substantially. The increasingly central role played by China, together with other developing countries, at last year’s G8, G20 and Copenhagen summits underscores the country’s growing geopolitical importance.

Over the last 10 years, China’s inbound investment has grown markedly. Over the next decade, the outstanding feature is likely to be a sharp rise in outbound investment. This has begun already, with major oil deals signed in Venezuela, Brazil and Russia and significant investments made in natural resources in Africa and Australia. According to China’s Ministry of Commerce, China’s outbound investment from non-financial sectors probably rose to around $42bn last year.

Corporate M&A has also picked up, with China becoming a major acquirer. Late last year, as many of the developed world’s car makers languished, China moved towards adding Volvo and Hummer to its growing list of marques.

Domestically, the longer term trends are just as strong. Consumption is growing due to a combination of rising incomes, urbanisation and social intergenerational changes. Moves to increase the provision of pensions, healthcare and a social safety network are designed to reduce the marginal propensity of Chinese people to save. Ironically perhaps, it is traditional for many Chinese families to ensure that all their debts are paid in the run-up to New Year.

Important considerations

For us, as investors in China, political, economic, social and technological factors are all important considerations. Through the economic ups and downs, the Government can become involved in many industries. Often, the Government is the customer, producer, supplier and regulator all in one. It is important to understand government policy and intent, as these factors can change the outlook for an entire industry, either positively or negatively.

These factors are important in the context of China’s domestic A-shares markets. Here, the government is the largest shareholder and, with tight control of the regulator, it can adjust the supply of equities as demand changes. Inevitably, such actions impact the performance of A shares. This is one of the reasons we prefer to invest in Chinese companies listed in Hong Kong. Another is valuation. According to Bloomberg, the Hang Seng China Enterprises Index trades on 12 times this year’s earnings, which is undemanding by historical measures or compared to other major world markets. While we may see further periods of market volatility as investors seek reassurance that a tighter monetary stance will not impinge on Chinese growth, we continue to see many areas of value and scope for unexpected earnings growth that support the case for investing in attractive Chinese businesses over the next 12 months.

Charlie Awdry, manager of the Gartmore China