Positive signs of strong China and Hong Kong markets next year

Consumer goods, health care, technology, and infrastructure sectors favoured, while red flags raised over energy and some property stocks

PUBLISHED : Friday, 02 December, 2016, 10:52pm
UPDATED : Tuesday, 06 December, 2016, 2:58pm

Next year is looking promising for Chinese stock markets, although the macro economy may still be in for a bumpy ride.

In particular, analysts and fund managers favour consumer, infrastructure, and technology sectors, which should see improved earnings, but investors are being warned off some property developer and utilities shares.

“We envision a good year for Chinese equities,” said Wenjie Lu, a strategist at UBS Securities.

“Although China’s economic growth will weaken further in 2017, corporate earnings will grow in double-digits, backed by easy credit and abundant liquidity, as money flows out of the property market after tightening measures, and back into cyclical sectors, such as infrastructure,” he said.

Lu forecasts average earnings per share (EPS) for the MSCI China index to grow 12 per cent in 2017, versus low-single-digit growth in 2014, 2015, and 2016.

The MSCI China index tracks large and mid-cap Chinese companies listed in Hong Kong in local currency, as well as so-called B-shares, those traded in mainland Chinese markets in foreign currencies.

Lu predicts the MSCI to jump to 72 by the end of 2017, up around 20 per cent on its current level.

The Hang Seng China Enterprises Index, which tracks the performance of Hong Kong-listed Chinese companies, will also rise nearly 20 per cent to 11,700 by end-2017, according to his estimates.

Fellow researchers at UBS are equally upbeat on mainland China’s stock indexes.

They expect the Shanghai-traded CSI300 index – which measures the performance of large-cap companies on Shanghai and Shenzhen stock exchanges – to increase to 3,750 by the end of 2017, up around 5 per cent from the current level.

Jonathan Garner, an equity analyst with Morgan Stanley, is equally bullish on Chinese equities.

In a recent research report, he raised the rating for mainland Chinese stocks to “overweight” from “equal-weight” and upped his 2017 target for the Shanghai Composite Index to 4,400, 34 per cent higher than the current level.

The Shanghai Composite Index re-entered bull territory last month, registering a more than 20 per cent gain from its lows in late January.

Garner said the Chinese authorities may be prompted to keep “easy monetary conditions” in place next year due to the significant threat of trade protectionism conflict between China and the new US administration, and the relatively early stage of the Chinese recovery.

The recent tightening measures introduced on the property sector, specifically on second and third home purchases, he added, are already starting to force wealthy individuals to “reallocate” towards the equity market.

Garner forecasts average EPS growth for the Shanghai Composite Index to increase to 6 per cent in 2017.

“Overall, we expect a more extended and subdued bull market, as lessons have been learned by the regulator regards margin and futures trading, and policing initial public offering (IPO) activity,” he said.

Specifically, fund managers and equity analysts consider the consumer sector as one of the best performers in the year ahead, as China rebalances its economy to become less reliant on exports and investment, and more focused on consumption and service-driven industries.

“The consumer sector will be an important investment theme next year, ” said Gao Ting, a strategist for A-shares at UBS Securities.

“We favour quality names in consumer goods and services, whose growth is underpinned by structural trends in China’s economic rebalancing,” he said.

He recommends investors follow consumer goods producers and service providers in fast-growing segments such as food and beverage, education, culture and entertainment.

His top picks include Shenzhen-listed Zhejiang Huace Film & TV, the production studio, Shanghai-listed Chinese liquor maker Kweichow Moutai, and China CYTS Tours Holding, a top tour service provider.

Wee May Ling, an investment manager with China equities at Henderson Global Investors, is equally bullish on the consumer sector.

“Increased consumption, technology differentiation and the ability to satisfy the needs of millennials as a consumer group will continue to drive profit growth (for related companies),” she said.

Gao favours technology and health care companies, which are also expected to have strong growth potential, tipping Shenzhen-traded Shenzhen O-film Technology, an optoelectronic thin-film manufacturer, Wangsu Science & Technology, a leading content delivery network technology provider, Shanghai-listed Zhejiang Huahai Pharmaceutical, and Shenzhen-listed Hualan Biological Engineering, a major influenza vaccine manufacturer.

Andrew Swan, Head of Asian Equities at BlackRock, thinks along the same lines as Gao and Wee, suggesting consumer, internet and health care stocks can expect to do well in 2017.

“The Chinese government will be focused on growth stability through expansionary fiscal policy next year,” he added.

Gao also has a eye on stocks that could may benefit from further yuan depreciation, including exporters and multinationals whose earnings are sensitive to yuan weakness.

These might include home appliance maker Shenzhen-listed Midea Group and Hangzhou Hikvision Digital Technology, one of the world’s largest suppliers of video surveillance products, both of which have large overseas exposure.

Stocks with high-dividend yield, such as state-owned car maker SAIC Motor, may also appeal to investors in a “persistently low-yield environment”, Gao said.

Companies in construction and environmental protection, for instance, could benefit from rising orders from public-private partnership projects in 2017, including Shenzhen-listed Beijing Origin Water Technology, a water treatment solution provider, and Focused Photonics, a manufacturer of analytical instrument for environmental monitoring.

UBS’ Lu Wenjie believes Hong Kong-listed China Resources Cement, Beijing Urban Construction, and China Railway Construction could be the types of stock to benefit from a likely infrastructure-led cyclical recovery in 2017.

“As real estate activity cools further in 2017, the government is likely to boost infrastructure investment to counter headwinds to growth,” he said.

And financials should also have a better year in 2017, he said, as bank earnings accelerate on the fading impact of interest rate cuts and slower bad loan formation, while non-bank financial stocks should recover from a lower base.

He expects listed banks’ average earnings growth to improve to 5 per cent in 2017, while non-bank financials may reverse their earnings decline, and swing into positive growth, even as healthy as 18 per cent.

Adrian Mowat, chief emerging markets and Asian equity strategist at JP Morgan, particularly favours Chinese banks.

“Over-capacity industries have returned to profit, which is bullish news for banks, as it reduces their asset quality concerns,” he said.

Interest rate increases on the back of a stronger economy should also help banks gain “marginally positive earnings momentum”, he added.

JP Morgan currently rates Hong Kong-traded Bank of China “overweight”, and gives it a price target of HK$4.8 by the end of 2017, a 35 per cent premium on the current price.

Mowat is also tipping Hong Kong-listed Macau casino operators, as “profit growth in China is nicely correlated with gaming revenues”.

“A fair number of the players in Macau will be owners of small to medium enterprises, where profitability is recovering, so they will have a bit more money to play with,” he said.

However, he is bearish on Hong Kong property developers, within a weak macro-economic environment.

JP Morgan has also raised a red flag over H-shares in Chinese power producer Huaneng Power, due to the rising coal price. And they rate Hong Kong-listed China Oilfield Services as “underweight”, as low oil prices continued to pressure the energy sector.

UBS analysts give an “underweight” rating on real estate-related H-shares, due to policy tightening on both sales and refinancing.

In general, the utilities sector is among their least favourites, because of elevated coal prices and over-capacity of thermal power.