After a much stronger-than-expected Year of the Rooster, markets appear much more positively disposed to China’s medium-term economic outlook. The prognosis for a structural slowdown in Gross Domestic Product (GDP) growth remains in place, yet more credence is being given to the potential for China to negotiate this slowdown in a controlled manner.
Importantly, we think, China is making a much more concerted attempt to regulate its shadow financial sector. This is a delicate operation with two key objectives: to prevent future risks to financial stability being generated by continued poor practices, and at the same time to tighten regulations in such a way as to not upset broader financial stability. Solid steps in the right direction have already been taken, and we believe this should be regarded positively, but it remains important to keep a lookout for possible unintended consequences that could arise.
Slowing Credit Growth
Credit growth slowed gradually throughout 2017, and we expect this trend to remain in place so long as economic activity does not surprise to the downside. The People’s Bank of China has said that it will keep monetary policy “prudent and neutral” again in 2018. The housing market slowed noticeably in 2017, with residential home sales contracting in the third quarter – but in a much more geographically differentiated manner than has typically been the case – before showing some improvement in November and December. House-price growth also seems to be bottoming out, which we see as pointing towards a possible soft landing for the housing market in this recent mini-cycle.
The Year of the Dog therefore starts with some continuing economic momentum that we expect will gradually soften as the impact of the credit-growth slowdown in past months permeates through. More resilient growth in the services sector (as the economy continues its rebalancing towards consumption away from investment) should, we believe, once again offset slower industrial production, while exports may provide a cushion in this department and indeed perhaps even some upside surprise, if global growth remains on track.
Against this backdrop, we continue to feel broadly optimistic about long-term structural investment opportunities in China. We find these on a highly selective basis within services sectors exposed to consumers who have seen significant increases in their real wages over the last two decades and now have more disposable income to spend on health care, e-commerce, insurance, travel or other goods and experiences. We do not have any investments in Chinese banks, property, heavy industry or state-owned enterprises (SOEs) which comprise the majority of the index and which, we believe, offer a much less attractive risk/reward profile. China wants and needs to move up the value chain and is spending an increasing amount on research and development in order to achieve this.
With one fifth of the world’s population living in China, data capture of their characteristics, habits and purchases can be extremely powerful. Capital-light internet platforms are able to use this information to potentially strong advantage via increasingly powerful artificial intelligence. For this reason, we continue to be excited about the potentially long growth ‘runway’ for many Chinese internet names. As with any emerging market, we do not expect the returns from even the best parts of the Chinese market to accrue in a straight line, but are confident in the potential for selected businesses to compound profits at attractive rates of return over a five-year investment horizon.
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