‘Overweight’ offshore China equities is key theme of 2017, says CLSA’s Wood

Banks, commodity stocks and insurers are the key sectors to watch as outlook for corporate profitability improves and demand for raw materials picks up

PUBLISHED : Tuesday, 07 February, 2017, 6:49pm
UPDATED : Tuesday, 07 February, 2017, 10:40pm

Investors should take an “overweight” position in offshore Chinese equities this year, as supply-side reforms are putting the country’s economy firmly back on track, according to a leading analyst.

Christopher Wood, an equity strategist for CLSA, said government policies aimed at cutting excess capacity in core industries had helped the struggling corporate sector to improve profitability.

“The key thing in Asia is to overweight Chinese equities,” said Wood in Hong Kong on Tuesday.

The MSCI AC Asia Pacific ex-Japan Index, which tracks large- and mid-cap stocks within the region, has given a 24.8 per cent weighting to Chinese stocks, the highest in the index, according to data released by MSCI on February 1.

But Wood recommended investors further increase the weighting to 29 per cent of their stock portfolio for the region.

If the supply-side reform continues, it will create a virtuous cycle
Christopher Wood, CLSA

Currently, MSCI’s stock indices only track Hong Kong-listed Chinese companies and B shares in the mainland that are denominated in foreign currencies and accessible to foreign investors. A shares, denominated in renminbi in the mainland, are not included in the MSCI indexes.

“The most important reason [to increase the weighting] is that China’s producer prices have turned positive,” he said. “I believe it’s a long-term change.”

China’s producer price index returned to positive territory for the first time in 54 months in September and has since accelerated. It hit a five-year high in December, up 5.5 per cent year-on-year.

Producer prices had been stuck in negative territory for years because of weak external demand and overcapacity in many industries, such as steel and coal.

A pick-up in PPI provides a boost to companies’ profitability and allows them to reduce their debt burden.

The People’s Bank of China recently increased interest rates in the money market, indicating a switch of policy tone from pro-growth to an emphasis on deleveraging and curbing asset bubbles.

Although the tightening of funding conditions is potentially bad news for Chinese equities, the effect should be offset by the boost from China’s economic growth recovery, Wood said.

“After all, the PBOC’s tightening is not going to be aggressive this year,” he said.

A steadier yuan is also positive for market sentiment.

“China has maintained its control on the capital account. So there should be no worries about its currency,” he said.

Since late 2016, the Chinese authorities have stepped up their controls on capital outflows, making it more difficult for individuals and companies to move money out of the country.

The yuan has stabilised since the start of the year, having fallen 6.7 per cent against the US dollar in 2016, its biggest annual loss in more than a decade.

China industrial inflation surges on coal and steel price rally

Among sectors, Wood advised investors to watch Chinese banking stocks, as the supply-side reforms have led to an improvement in profitability of industrial companies, which should help enhance asset quality and reduce stress in the banking system.

“If the supply-side reform continues, it will create a virtuous cycle,” he said.

Commodity and energy stocks should also benefit from the pick-up in China’s producer prices, which will translate into stronger demand for raw materials from the world’s second largest economy, Wood said.

Wood advised investors to “underweight” Hong Kong stocks and reduce their weighting to 6 per cent from the current 9.5 per cent in the MSCI AC Asia Pacific ex-Japan.

He said US President Donald Trump’s fiscal stimulus plans and future rate increases by the Federal Reserve may attract funds to flow back to the US, which could pose a threat to Hong Kong equities.

Several investment banks are also bullish on Chinese equities in 2017.

Jing Ulrich, vice chairman for Asia at JP Morgan, said recently that the investment bank expected the MSCI China Index to jump 15 per cent in 2017, boosted by better corporate earnings and the stabilisation of the Chinese economy.

Citibank also anticipated the MSCI China Index to increase 14 per cent in 2017, favouring industrials, raw materials, insurance, and bank stocks.

However, some investors are more bearish.

Well-known investor Jim Rogers said recently told CNBC that he was not optimistic about investment prospects in China and is in a holding pattern of assets related to the country.

He said President Trump’s hawkish stance on China will stall the country’s economic growth, and a potential trade war between the two countries will cause “economic upheaval and turmoil”

Goldman Sachs analysts also cited the ‘Trump factor’ as a big risk to the MSCI Asia ex-Japan Index in a January report, saying a 5 per cent drop in US import growth may lead to an 8 per cent decline in the index, with South Korea, China and Taiwan stocks among the worst hit.