This Chinese New Year ushers in the Year of the Ox, which began on Friday 12th February. The Ox is thought to be a symbol of reliability, strength, patience and caution. It is also associated with harvesting, fertility and prosperity.
After a tumultuous 2020, many an investor will welcome financial markets that are reliable, strong and prosperous, even if they have to act with patience and caution.
Could the Year of the Ox be a “bullish” omen?
Economic strength ahead
China was the only major world economy to post positive growth in 2020 thanks to its effective handling of the Covid-19 pandemic. Strict lockdown measures, widespread testing, a compliant population and vast government stimulus measures appear to have done the trick.
The fourth quarter of last year saw economic growth rise 6.5% year-on-year (y/y), as normalisation continued. This took full-year 2020 growth to 2.3%. By contrast, the US economy shrank by -3.5%, while eurozone economic growth contracted -6.8%.
Schroders’ economics team forecasts an expansion of 9% in China’s economy in 2021. And the first quarter could see growth climb as high as 15% to 20% y/y. This is due to the lagged impact of stimulus measures, as well as the effect of having a very low base for comparison after the steep economic decline in the first quarter of 2020.
Beyond this, in 2022, the economics team expects China’s economy to normalise towards trend growth of around 5.5%.
What could this mean for equities?
Financial markets have been focusing on this economic strength: the Chinese stock market, as measured by the MSCI China Index, was up almost 30% in 2020 and has gained over 15% so far in 2021 (source: Refinitiv, 9 February 2021).
Global investors’ still-light positioning in Chinese equities and reasonable valuations relative to global peers could encourage further inflows to the market in 2021. In particular, the mainland A-share market, should continue to attract greater attention as international investors look to increase their long term allocations to the market.
Investors bought aggressively into “lockdown winners”, including e-commerce and online gaming, healthcare, cloud computing and technology more broadly – where earnings are benefiting from an accelerating shift in consumption patterns post crisis.
From a sector perspective, we believe those sectors which provide exposure to long-term growth themes in the country will continue to outperform.
Tech hardware is one such industry, as people continue to work from home through 2021.
This is leading to increased demand for tech hardware, including networking power, but there hasn’t been a significant supply response. This mismatch in demand and supply means we think the outlook for profit margins in this space looks healthy.
Overall though, we are cautious about internet/e-commerce companies given high valuations and anti-monopoly regulation that was introduced in November. We think this could cloud things for the sector in the near term.
Elsewhere, we like areas including industrial automation, electric vehicles and components, and supply chain localisation amid international trade frictions.
However, a broad global economic recovery following a successful vaccine development should benefit cyclical sectors, where valuations are still cheap currently compared to growth sectors. These should pick up momentum as vaccination programmes progress, and daily new cases of coronavirus around the world recede, providing confidence in the normalisation trade.
What are the risks?
Since the discovery of Covid-19 vaccines in the final quarter of 2020, hopes for an exit from the pandemic and recovery in economic growth have been building. There is therefore the potential for disappointment, and any change to the positive outlook would likely have implications for global financial markets in general.
Long-term strategic competition with the US is another area to monitor. Trade tensions escalated and expanded into other areas such as technology and capital markets under the Trump administration. We expect US policy to be more predictable under President Biden. But it remains our base case the tensions between the sides will be a drag on investment and global growth in the years ahead.
In response to these rising tensions, China has emphasised greater “self sufficiency” in terms of technology and its increasing effort to support companies in strategic industries. These include aerospace, IT, semiconductors and robotics. We believe that there will be some attractive opportunities for investors as “national champions” begin to emerge.
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Article by Stephen Kam, Head of Product Management, Asia ex-Japan Equities
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