There are four main reason to be bullish on Chinese equities, Yun told FSA. The first is the announcement by the index provider MSCI that it will start including China A-shares in its global emerging market indices in May 2018.
“Global investors, particularly the US funds, have underweighted Chinese equities for a long time,” Yun said. MSCI’s decision will mandate funds to adjust their portfolios in accordance with their benchmarks, and that in turn will contribute to a higher interest in A-shares from global investors.
Yun’s second reason is that Chinese equities, with their relatively inexpensive valuations, are still an attractive alternative to the fully valued US equity market, which has reached the mature stage of the market cycle.
“The valuations of Chinese companies remain inexpensive despite that they have gone up by more than 20% this year,” he said.
The third reason is that the Chinese economy is large, second only to that of the US, and still growing at a pace between 6% and 7% per year. “I am sure there are some companies that should benefit from this trend,” Yun said.
The fourth reason is related to the consolidation of political power by China’s president Xi Jinping during the 19th National Congress of the Communist Party of China in October. “Xi will continue to lead the country for at least another five years, in which he will focus on bringing more economic policies to help further improve the standard of living in China,” Yun said.
With inflation remaining low, which helps drive corporate earnings, China is now in a “Goldilocks situation”, according to Yun, and he expects it to continue in 2018.
Debt worries
Newton IM’s Brendan Mulhern has raised concerns over China’s level of debt, misallocation of capital and the country’s ability to mitigate the effects of a potential slow-down of the global economy. However, Yun is confident in the Chinese government’s ability to safely navigate through these threats.
“The government has put in place measures to deleverage some institutions,” Yun noted. They include pressure on listed companies to reduce investing overseas and on the four major banks to suspend risky lending.
“Obviously, they will do it on a gradual basis, trying not to affect the economy,” Yun said. Although the GDP growth in 2018 is expected to be lower than this year, it is still likely to be between 6% and 6.5%, which Yun finds fully acceptable. “Slowing down is good for China in the long term,” he said.
The slowdown will be partly an effect of softening in the property market, which the government has attempted to cool down. “The property sales may slow down a bit, affecting the overall economy,” Yun noted.
In the meantime, reforms in the inefficient state-owned enterprise (SOE) sector will continue, said Yun, adding that more restructuring is expected.
Sector choices
Investors in Chinese equities need to be selective. The companies that will be included in the MSCI index next year are likely to see a positive effect on their share prices, as foreign funds and investors rebalance their portfolios.
On a fundamental basis, Yun expects the technology sector to continue doing well, as well as pharmaceuticals and health care, which will see growing demand for their products and services in China’s ageing and increasingly wealthy society. He also likes the consumer sector, which continues to grow faster than in developed countries.
In a more distant future, Yun expects the Belt and Road initiative to have real economic impact once the infrastructure such as rail links to Central Asian countries and the Middle East is in place. The need for funding of the Belt and Road is likely to boost the fortunes of the financial sector and of the renminbi itself.
Yun sees the biggest risk for China in the realm of geopolitics, and in particular with its troublesome neighbour North Korea. In 2018, the situation could become even more tense.
