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Less fire from Chinese Dragon in 2018

Naomi Waistell  |  23 Feb 2018Text size  Decrease  Increase  |  
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After a much stronger than expected Year of the Rooster, markets are more positively disposed to China's medium-term economic outlook.

The prognosis for a structural slowdown in 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, a more concerted attempt is being made to regulate the 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 this should be regarded positively, while at the same time keeping a lookout for possible unintended consequences that could arise. 

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, pointing towards a possible soft landing for the housing market in this recent mini-cycle.  

Dog slower than rooster 

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 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, the Newton Global Emerging Markets team continues 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 healthcare, ecommerce, insurance, travel, or other goods and experiences. 

Where we see opportunities

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, we believe, offer a higher-risk profile at a much lower return. 

China wants and needs to move up the value chain and is spending an increasing amount on research and development to achieve this. One-fifth of the global population lives in China--thus data-capture of their characteristics, habits, purchases et cetera is extremely powerful. 

Capital-light internet platforms are able to use this to strong advantage via increasingly powerful artificial intelligence. For this reason, we continue to be excited about the long runway for growth in Chinese internet names and see this long-term horizon as a key differentiator in our approach. 

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 to compound profits at attractive rates of return over our five-year investment horizon. 

Political manoeuvres 

According to Aninda Mitra, BNY Mellon's senior sovereign analyst, in the weeks ahead, it will be interesting to see the manner in which the Chinese authorities manage to balance the road map for reforms without destabilising growth expectations or eroding their own reform credibility. 

The 19th Party Congress clearly provides the scope, authority and oversight to President Xi and to the incoming administration to intensify a wide range of reforms and deal with emerging risks within the global trading system. 

In our view, the de-leveraging effort so far has been quite successful, but the easy part is nearing an end. Raising the financial and regulatory cost of leverage has resulted in a sharp slowdown of shadow banking, lowered leverage, and resulted in a de-risking of inter-connected funding structures. 

The brunt of these efforts has been felt by the non-bank financial institutions and second tier banks. As a result, aggregate leverage has recently begun stabilising (as a percentage of China's GDP). 

There are also risks confronting China. One key risk is that of higher protectionism in advanced industrialised countries. In our view, this risk goes beyond just the US. We believe China recognises the growing risk of a global backlash even as it pursues its strategic technological and geo-economic objectives. 

But a more accommodative gesture would also shore up regional trading arrangements and CNY acceptability. The key question, therefore, is the likely response and nature of retaliation to an uptick in trade tensions. 

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Naomi Waistell is a portfolio manager at Newton Investment Management, the London-based global investment management subsidiary of BNY Mellon. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. 

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is a portfolio manager at Newton Investment Management, the London-based global investment management subsidiary of BNY Mellon.

This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. 

© 2020 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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