Download IT`S fun to see global stock markets are finally off to a roaring start

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IT’S fun to see global stock markets are finally off to a roaring start, following a difficult and gut-wrenching year. Asian and Emerging Market (EM) equities have regained
some lost ground, after dropping 20 percent in 2011. In January alone, share prices in
Hong Kong, India, and Argentina are up by at least 10 percent, while our very own
Philippine Stock Exchange Index has gained 7 percent—a reason to celebrate, considering the average monthly return on EM stocks is only 1.2 percent.
markets higher.
This is all great, but can the rally last? Let’s put things into perspective. We still have unresolved problems in Europe, marred by political chaos, rising recession risk and about
US200bn in maturing Euro zone debt in the first quarter of 2012. On the other hand,
positive reports from the US (i.e. manufacturing, unemployment, housing, corporate
earnings) all hint of a recovering economy, reviving investor risk appetites and pushing
In our part of the world, inflation is falling and regional policy makers are now focused on stimulating Gross Domestic Product (GDP) growth in emerging Asian economies—which, according to International Monetary Fund
forecasts, will reach +7.5 percent in 2012-2013, compared with less than 2-percent growth for developed economies
(i.e. the US, Europe and Japan). While this paints a rosy picture for Asia, the actual growth potential still largely depends on the financial prospects of China—which is the world’s second-largest economy and the engine of the Asian
growth miracle.
There’s been a lot of pessimism on China, which has underperformed Asian markets by 12 percent and global markets by 18 percent over the last two years. These reflect investor fears over a drastic slowdown in the Chinese economy (hard landing scenario) and concerns on a property sector collapse triggering a full-scale banking crisis. Are
these frightening scenarios realistic? Will Asian stock markets crash as the gigantic Chinese economy grinds to a
halt? Or do such uncertainties merely mask a golden opportunity for investors seeking alpha (above market returns)?
To find my answers, I spent the past week freezing in Beijing to listen to government officials and captains of industry talk about the future of China. I also spoke with executives of various listed companies (i.e. Petrochina, Renren,
Wumart) in different sectors and inquired about their business outlook and strategies. My goal was not just to understand, first hand, the likelihood of a hard landing, or if government stimulus measures could sustain growth. I
wanted to know if the Chinese growth model was actually broken (as current prices suggest), and if not, where the
best investment prospects in China really exist.
First on my agenda was a Deutsche Bank (DB)-hosted briefing with Jian Wang, Secretary-General of China’s National Development and Reform Commission. He expects Chinese GDP growth to slow down to 8 percent in 2012,
to 7 percent in 2013 and to 6 percent in 2014. However, he also anticipates growth to rebound to 9 percent per year
over the next 15 years. Wow, and Mr. Wang was being conservative.
He believes the key is urbanization. China only has a 500 million urban population, which means the remaining
60 percent of the total population (or 800 million) are the farmers—which fall behind the urbanization rate China
should be at, given its’ achieved level of industrialization. With potentially 800 million people going into the cities in
the next 15 years and then increasing their spending by three times, to align with what the urban residents spend, it
should significantly boost domestic consumption growth and GDP growth.
To support sustainable growth, China’s 12th Five-Year Plan (FYP) also focuses on growth structure reform, which
outlines an improved wealth distribution program and a shift toward growth in rural and agricultural regions, central and western cities (from traditional coastal cities) and, of course, domestic consumption over exports. On top
of this, note that China is ending a cycle of rising interest rates (tightening), with further expected cuts in its reserve
requirement ratios and even borrowing rate cuts in the first half of 2012. These make for an environment conducive
to growth and good for stocks.
Meanwhile, risk in the banking sector is more of liquidity, and not of solvency. Weak deposits, a slowing economy
and controversial loans to local governments are valid concerns. However, the government has been able to curb
speculation in the real estate sector, by raising down payments on second homes to 60 percent, banning mortgages
on third home purchases, hiking lending rates and imposing new property taxes (Shanghai, Chongquing), among
other things. Property prices have already dropped significantly and may be stabilizing. Meanwhile, the banking
system remains liquid, loan default rates are below 70 percent and there’s plenty of room to lower reserve requirement ratios for banks from the current 21 percent. Chinese banks, unlike their European counterparts, will support
growth if needed.
Ultimately, I went home convinced that the growth scare in China is exaggerated, the risks to its financial sector are
manageable and the big 16-percent, two-year drop in the MSCI China index (MXCN) is largely overdone. Accordingly, I won’t be surprised to see Chinese equities rebound and outperform Asian and global stock markets this year.
DB’s Jun Ma, one of Asia’s best economists, forecasts the MXCN to jump as much as 30 percent this year, due to decent growth, inexpensive valuations (10 times price-earnings ratio) and improving sentiment.
Prudent strategy is still to bet on the government—by investing in companies in growth sectors outlined in China’s
12th FYP, which can grow by 15 percent to 25 percent. These include independent power producers, clean energy
companies, technology firms and, of course, the consumer sector. I also interest-rate sensitive stocks like the big,
liquid banks and select property developers—due to massive valuation discounts, decent growth and benefits from
monetary easing. As for our Chinese stock picks and other favored sectors, you can check out Part 2 of this article.
The author is the Investments Director and Portfolio Manager for International Equities at ATR KimEng Asset Management and is a member of its investment committee. For comments, you may e-mail him at julian.tarrobago@
atram.com.ph.