China consumers seen as key amid hot-money fear

Investors are not focused enough on changing consumer-spending patterns in China that are driving business growth and investment opportunities, says Robert Horrocks of Matthews Asia.

The CIO sees 7-8% economic growth in China as sustainable, and in a recent sit-down with AsianInvestor noted low stock valuations of nine-times 2013 earnings with a dividend yield of 2.7%.

“You have a high rate of productivity growth [in China], good profitability in listed companies and there is no sign that businesses’ return-on-equity will fall much, on average,” he states.

But countering such bullishness, Bank of America Merrill Lynch argues that China's recent equity rally is being driven by speculative flows on the back of monetary easing in Japan and the US, indicating this is hot money not based on fundamentals.

Horrocks, it should be noted, was talking from a 10-year investment perspective, not a short-term horizon. The engaging CIO has previously raised the prospect that Matthews Asia might look to launch a China-related product within five years.

Matthews Asia is a US-based bottom-up manager with around $21 billion in AUM, a third of which is allocated to Chinese companies listed globally.

Horrocks is bullish on China's consumer sector, on the basis that rising wages will give workers more disposal income. Increasing purchasing power will drive spending on goods and services domestically and throughout the region, he says.

“Greater income disposal means people spending not just because it’s cheap, but to be able to express something about themselves, it is a different kind of consumption,” Horrocks notes.

“There will be a rising tide of retail distribution outlets and department stores, the spend on advertisements will increase immediately and, with the help of infrastructure such as online selling, consumers will be become brand-aware and companies can build strong businesses.”

He favours consumer staples and consumer discretionary, as well as healthcare and insurers, plus property-related firms in line to benefit from increased retail consumption (shopping malls, shops) and real estate investment trusts.

He does not see monetary loosening as likely from Beijing this year as Chinese authorities strive to rein in property and credit growth. But Horrocks is unfazed by the fact this is not positive for equities.

He also takes a positive view on machinery on the understanding that workers will be replaced to enhance productivity. Capital goods is a market on the up, he says, while the firm is underweight cyclicals.

But David Cui, China strategist at BoA Merrill, sees hot money flowing into China, partly due to global monetary easing and low interest rates, encouraging investors to take on risk and drive foreign funds into the A-share market.

“My sense is that a big reason why people are willing to pay higher P/E multiples for the same stream of earnings is largely because of money inflow," he says. "Once the buying starts, people are afraid of missing out and it gains momentum.

“People feel more positive but there is no deep conviction in a fundamental turning around of what’s going on in China. I still think it is a range-bound market at best."

In 2011, average capacity utilisation hit a two-decade low of 60% in China, from 80% during pre-crisis times. Dutch asset manager Robecco has said this may put a dampener on earnings growth, forecasting that operating-margin growth for MSCI China (ex-financials) will sink to 9% in 2013, from 11% last year, and below the global average of 10%.

Strategically, BoA Merrill is looking to reallocate assets from outperforming sectors such as property into underperforming sectors such as oil, insurance, healthcare and consumers (meaning Cui ends up in a similar place to Horrocks).

The Shanghai Stock Exchange Property Index returned more than 30% from its trough in late August, according to Bloomberg data. In contrast, the MSCI China consumer discretionary index has increased by 4.59% year-to-date.

Separately, JP Morgan Asset Management reports that investor confidence in Hong Kong has risen to 123 in the fourth quarter of 2012, from 109 in the previous three months (a score of 100 means neutral).

The pick-up was pronounced with regards to mainland China, with 85% of the 508 surveyed believing it has the highest potential for growth in 2013.