China’s economic rebound from the coronavirus shock allied to enduring structural growth promises to propel local company earnings in Year of the Ox – in keeping with the creature’s fabled characteristics.
The symbol for the Lunar New Year starting on 12 February is an ox in the Chinese zodiac. Oxen are esteemed in Chinese culture for strength and hard work. The ox-like endurance of China’s economy will enable productive firms to plough ahead, to the benefit of investors.
The MSCI China A Onshore Index surged more than 40 per cent last year. This rally reflects the resilience of domestic company earnings after China acted quickly to reopen its economy from lockdowns. Further, it highlights the positive outlook for earnings in the year ahead.
China recorded 2.3 per cent year-on-year growth in GDP last year – one of only two G20 nations in line to record positive growth for 2020. Chinese authorities were able to bring COVID-19 infection rates down sharply, while its policymakers stimulated the economy. This earlier restart relative to other economies gives investors greater clarity on the outlook for earnings.
Initially China’s resurgence was powered by a pick-up in industrial production – factory output ranging from technology and communications materials to facilitate working from home to personal protective equipment such as masks. Allied to fiscal stimulus measures, this precipitated a revival in domestic consumption and fixed asset investment.
This inherent economic strength is driving China’s A-share market to become a consensus long among investors, prompting fears of a bubble similar to 2015. Local retail participation is elevated, as is global investment into A-shares via the Stock Connect trading scheme.
Nonetheless, investors can still find relative value in A-shares. With a forward price-to-earnings ratio of 17x (based on 2021 earnings forecast), the MSCI China A Onshore Index is trading above its historical average. However, it remains at a 40 per cent discount to the S&P500 on a price-to-book basis and is 23 per cent cheaper on a price-to-earnings basis.
These valuation levels appear well supported, too, with consensus earnings growth forecasts for 2021 comfortably in double digits for companies in the MSCI China A Onshore Index.
Growth momentum is likely to slow this year as a natural consequence of China having recovered so rapidly – official GDP data show China already back on its pre-COVID trend.
But while investors can expect a reduction in fiscal support, it doesn’t mean China will suffer a major slowdown – only that financial conditions will move from accommodative to neutral. Our Research Institute forecasts that China’s GDP will grow in high single digits for 2021.
Encouragingly, authorities have pledged not to tighten policy rates too quickly – pointing to stability. If firms can continue to borrow at low rates, it bodes well for company earnings.
Moreover, policymakers retain dry powder to pull on monetary and fiscal levers and inject liquidity into the system to safeguard China’s recovery. It is because China is growing that policymakers are able to employ orthodox policies – which reduces risks of fiscal slippage.
However, there are still sectoral divergences for investors to watch out for. Looking ahead, consumption will become the key indicator to assess the health of China’s economy.
Investors might target quality consumer discretionary and consumer staple stocks in line to benefit from China’s structural growth. COVID-19 has changed some spending habits for good as people shop from home, supporting areas such as online delivery and digital healthcare.
Another area where investors can anticipate growth is green energy, with China committed to achieving carbon neutrality by 2060. This transition will require mammoth investment into firms that provide renewable energy, batteries, electric vehicles and related infrastructure.
Already Chinese firms are global leaders in the renewables supply chain. China’s wind turbine makers account for 26 per cent of global capacity and its battery makers 78 per cent. Moreover, China is responsible for 91 per cent of silicon wafer production to harness solar energy. We believe investors should focus on equipment makers and companies operating within the value chain.
Chinese provinces and cities will be at the forefront of purchase orders for equipment to source wind and solar energy, and the batteries to power it. We have seen some renewable energies reaching grid parity – where cost of production is the same as for fossil fuels.
We also see opportunities to invest in the electrification of transport – specifically in makers of batteries that power road vehicles – and in firms positioned to help China upgrade its national electricity grid to deal with anticipated growth in wind and solar energy.
Overall, investors need to think carefully about where to commit capital and what to avoid in the year ahead. But thanks to the ox-like resilience of China’s economy, they won’t be short of compelling growth options.
Nicholas Yeo, head of equities – China, Aberdeen Standard Investments
