China's economy will achieve a soft landing, according to Peter Lees, F&C's Head of UK Equities.
Despite recent disappointing growth data, which showed the slowest pace of growth in two years, China's economy will achieve a soft landing, according to Peter Lees, F&C's Head of UK Equities, whose Standard & Poors AA-rated F&C UK Alpha Fund has significant exposure to emerging market earnings through UK-listed companies. Lees returned this week from a week-long visit to China, where he found a country quietly confident in its ability to develop domestic growth efficiently.
Lees commented: "Twenty years ago, the Chinese were reticent to talk politics and business, but now they are openly and excitedly discussing their plans for growing and sustaining a strong domestic economy. What became clear throughout the week was the consensus view that the Chinese have no real respect for either Europe or the US, specifically the politicians for their utter lack of a cohesive and effective plan to tackle their debt problems. They can't quite believe just how weak these two once-great political blocs are, and view Southern Europe as little more than an emotional nightmare. They will seemingly only invest in European assets if and when they are in the abyss, but for now have no real interest."
One view expressed to Lees was general bemusement at the Obama administration's controversial Currency Exchange Rate Oversight Reform Act which, if passed by Senate, will allow the US to raise tariffs on Chinese imports which it claims are unfairly cheap owing to an undervalued renminbi. The Chinese have generally found it hard to comprehend the hard-line stance of the US when they are effectively speaking from a position of weakness. Lees explained: "Whilst the US has virtually no cash on its balance sheet, China has an abundance at its disposal and believes that the plans as they stand now would do nothing but cause a great deal of pain for an economy that can ill afford it. Consequently, they can't quite comprehend why the US are so reticent to extend the hand of friendship."
Lees sees domestic development rather than exports as the primary focus for China, which still has a significant way to go to attain the urbanisation already achieved by eastern economies such as Japan. Chinese authorities are keen to encourage more of the population to come into the cities, to offer the middle class the high standard of living that they desire and to improve living conditions for those who reside outside the cities.
Resources such as iron ore, coal and copper are viewed as being crucially important in making this happen. Coal from countries such as Indonesia is in abundant supply for now; however, it will only be a matter of time before those countries want it for themselves or perhaps to supply the likes of India where demand is greater.
Lees found that the Chinese are happy to admit that, despite the nation's impressive balance sheet, they need the expertise and creativity of the West. This is where Lees believes UK companies can come into their own.
"Whilst China wants to develop its infrastructure, its residents want luxury goods and efficient mobile and broadband technology. We estimate we currently have around 40% exposure to companies whose revenues we believe are set to benefit from this expansion, through the provision of expertise in building new electricity grids and subways, in addition to telecoms and technology. From an investment perspective, we anticipate strong demand for the miners in terms of both infrastructure construction and coal for power generation. As such we believe long-held positions Xstrata and Rio Tinto can benefit, both of which are hugely misunderstood and undervalued by the market currently."
Elsewhere, Lees believes that Tesco has found a real sweet spot in China, where the scope for the construction of hypermarkets between now and 2020 is significant. Importantly from an investor's perspective, Tesco will be working closely with a number of local partners both in terms of expertise but also financing. In Lees' view this expansion should not put too much strain on the balance sheet and by 2015 it is estimated that Tesco's Chinese operations could be delivering some £4bn in sales. Elsewhere Lees also likes international engineering firm GKN following increased demand for their driveline products. Where capacity constraints are an issue and there are very few players in this space, the auto industry heavyweights are working increasingly closely with GKN to add new driveline capacity to enable them to increase their output, which means greater earnings visibility for the company in the years to come.
Lees cautions that much of this capacity building is in preparation for 2016 when the demographic issue comes to the fore and the elderly in China are predicted to outnumber the young.
"One of the main reasons behind such ambitious development in China is that it is an important part of their five-year plan to grow their economy and encourage young people into high net worth jobs such as biotech and aerospace, expertise that they can subsequently export. They are a nation that don't ‘do' debt, so bust is bust and there is no-one to bail you out. They may be the world's largest economy in 2020 but they view longevity in sustaining this position without going into debt as the greater achievement."
So what now?
While government and consumer balance sheets back at home remain stretched to say the least, that of UK plc is in robust health, with companies experiencing strong profits, high margins and excellent cash flow
Lees says his position has similarly not altered from that at the beginning of the year, concluding: "We remain excited about the companies in which we invest; if you choose the right stocks, right management teams, in the right place, investors are still in a position to harness reasonable returns and in UK companies with exposure to emerging markets we feel we have that option. I genuinely believe the UK equity market offers fair value and, in my view, now is an excellent entry point."
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