Stocks to watch as China bounces back

The latest manufacturing data from the world’s second-largest economy has indicated that the recovery pace increased in June. The Caixin manufacturing purchasing managers’ index showed its highest reading for 2020, rising to 51.2 in June from 50.7 in May, suggesting that industrial production is accelerating on the back of improved domestic activity.

“GDP growth likely turned positive in year-on-year terms in [the second quarter] and we continue to anticipate a stronger recovery in the coming quarters than the analyst consensus,” Capital Economics said in a 1 July report.

“Although the prop to exports from COVID-related demand will fade over time, the rebound in domestic activity should keep the recovery on track…And the acceleration in infrastructure spending that is helping to buoy domestic demand for industrial goods has further to run given plans for even faster government borrowing in the months ahead.”

The London-based consultancy sees China’s economy recovering in 2021 to post a 10 per cent GDP gain, although it sees growth slowing to 4.5 per cent the following year as stimulus measures are withdrawn. In the first quarter of 2020, China’s economy shrunk by 6.8 per cent, its first such quarterly decline since 1992.

Beijing’s move in May to drop its official GDP target for the first time in almost two decades may have concerned investors, but analysts welcomed the communist-ruled government’s policy change.

“By gauging other economic targets, we estimated that the government is willing to accept growth as low as around 2 per cent year-on-year in real terms or 5.4 per cent year-on-year in nominal terms. These targets are more realistic in our view,” ANZ Research said in a 22 June report.

The Australian bank’s economists predict GDP growth of just 1.8 per cent this year, rising to 7.9 per cent in 2021, helped by policymakers’ conventional and unconventional fiscal and monetary stimulus measures. These include directly buying loans from regional banks and raising the official fiscal deficit to at least 3.6 per cent of GDP in 2020, up from 2.8 per cent last year.

Earnings recovery

Company earnings have reflected the effects of the COVID-19 shutdown, with energy and transport hit hard but consumer staples less affected, according to Robert Mann, Nikko Asset Management’s (Nikko AM’s) head of Asian equity.

“For China A-shares, first half profits were expected to be down by 27 per cent year-on-year, but were held up a little by the banking sector, with the figure down 50 per cent excluding financials,” he said.

“Transportation earnings were down 60 per cent and industrials down 66 per cent, but banks were positive and consumer staples, including stocks like Alibaba (NYS: BABA), were actually expected to be up 27 per cent”.

In the first six months of the year, “old economy” sectors such as energy, finance, industry and property lost ground to consumer staples, healthcare and technology, reflecting not only global trends but also a gradual trend towards domestic consumption.

Chinese stocks that gained in the first half included Kweichow Moutai (SHG: 600519), maker of Mao Zedong’s favourite drink, baijiu, along with Jiangsu Hengrui Medicine (SHG: 600276), internet giant Tencent (HKG: 00700) and Nasdaq-listed online retailers Pinduoduo (NAS: PDD) and JD.com (NAS: JD).

“So-called ‘new China’ profits should be down only by 5 per cent year-on-year, but ‘old China’ was down 65 per cent,” Mann said.

“The market consensus is for earnings growth to be around zero this year, but pharmaceuticals and biotech are expected to show 30 per cent EPS [earnings per share] growth, with energy and transport down by a similar amount”.

A structural shift towards technology, healthcare, consumer and tech-driven financial services is expected to remain a long-term investment theme for China, with fund manager Fidelity seeing opportunities across these sectors.

“Over the longer term, Chinese technology stocks, especially in the 5G construction and cloud computing areas that have underperformed of late due to the fears of new U.S. export restrictions, are expected to outperform,” Nikko AM’s senior portfolio manager, Eng Teck Tan, said in a 26 June report.

“The new technology cycle and the rapid pace of digitalisation in the post Covid-19 world should continue benefitting these tech-related stocks.”

Headwinds for China include increased trade tensions with the United States, including friction over Hong Kong, with restrictions placed on some key technology companies such as Huawei. A second wave of COVID-19 infections could also disrupt the anticipated global economic recovery, while an ageing population could result in structurally lower GDP growth in coming decades.

But Mann remains bullish, particularly given the global underinvestment in Chinese shares.

“When you have the global index with 50 per cent weighting in the United States, that’s a high weighting for one country with around 20 per cent of global GDP. China is the obvious place where people are underinvested; there are lots of excellent companies there and valuations don’t look expensive,” he said.

Australian investors seeking to participate in China’s expected upturn could consider exchange-traded funds such as the iShares China Large-Cap ETF (ASX: IZZ), VanEck Vectors China New Economy (ASX: CNEW), or the Nikko AM New Asia Fund (13432), which includes Alibaba and Tencent among its holdings.

Others with a large Chinese exposure include the Platinum Asia ETF (ASX: PAXX), described in March 2019 by Morningstar as “an exchange-quoted managed fund that provides listed access to a strategy we hold in high regard” and the BetaShares Asia Technology Tigers ETF (ASX: ASIA) which offers exposure to top Asian technology and online retailers.