We also see room for margin improvement at corporates, helped by cheaper raw material prices, reduced financing costs on rate cuts and better corporate cost control, as well as improving liquidity. In this supportive environment, we like beneficiaries of ongoing structural reforms, domestic consumption in selected upcycle trends, and companies delivering productivity gains
“Unbleatable” potential?
Goats can be stubborn but are also known for being tenacious, determined and sure-footed. We think investors could see the market climb higher after Chinese New Year as market participants update their investment models to reflect changing assumptions.
In particular, we think two factors will lead to a re-rating of China’s equity market. The first is the application of a lower risk-free rate by investment analysts, reflecting interest-rate deregulation and rate cuts. The second is a reduced equity risk premium due to deleveraging and progress on reforms.
Taken together, we believe that Chinese companies justify a higher valuation multiple than they are currently trading on, and we see plenty of scope for this from here, with both price to book and forward price/earnings multiples well below the historical mean.
In addition to this, we see room for profit margin expansion at Chinese companies, helped by cheaper raw materials prices including a lower oil price. Reduced financing costs now that interest rates have come down (and may still have further to go) and better corporate cost control in China should also help.
The path may be a little rocky, but the goat is surefooted and we see potential for the China equity market to climb higher in this scenario, especially if domestic investors continue to increase their allocation and are joined by overseas institutional investors, who appear to be underweight in China currently.
sorting sheep from the goats
The companies we think are likely to prove most attractive in this environment fall into three categories.
The first is beneficiaries of ongoing structural reforms, as the authorities work through the roadmap agreed at the Third Plenum.
This includes companies positioned to capitalise on financial reforms, for example a number of non-bank financials, as well as companies involved in green initiatives and state-owned enterprises which are undergoing reform. We think this is an interesting and potentially rewarding area of investment.
The second is companies active in the domestic economy and potentially well positioned to capture a growing share of Chinese domestic spending. Upcycling is a growing consumer trend in China, and something we think will continue to become more important as we go forward from here. Companies we like in healthcare, tourism, education and other service sectors fall into this category.
Finally, we like companies able to offer productivity gains as part of their business proposition. These are typically involved in the information technology and industrial automation fields, and offer excellent potential for long-term growth, in our view.
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