By Gustav Rhenman, Portfolio Manager, East Capital.
The outlook for Chinese equities remains upbeat after they rallied for the fifth month in a row. Among emerging markets, China stands out thanks to accelerating economic growth, rebounding industrial profits and fresh evidence that the country’s real estate market is not a bubble.
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Since September 2012, Chinese equity prices have been steadily rising. In the second half of last year, an increasing number of investors began to realise that China’s economy would not experience the hard landing they had feared. As it turned out, there was not much of a landing at all. Economic growth bottomed out during Q3 and has since accelerated close to the 8 per cent trend line.
The combination of accelerating economic growth, reduced political risk as well as a growing nervousness globally about bond valuations, has provided firm support for share prices. The rally has been underway for a few months but may well continue for some time still.
Valuation levels remain attractive and earnings growth outlook is positive.
On the subject of earnings, profit for Chinese industrial firms rose substantially in the fourth quarter of 2012 and we expect that trend to strengthen further in the first quarter this year. It is also encouraging to note that the highest profit growth comes from privately-owned companies, which now account for over 80 per cent of urban employment and two-thirds of all fixed asset investment. In other words, China continues on its slow but steady path away from a state-owned corporate sector to privately and publicly held companies.
Chinese PC maker Lenovo, one of our largest holdings, represents one such example. Lenovo has been the world’s fastest growing PC company for 13 consecutive quarters and is now also the world’s third largest maker of smart connected devices, which comprise PCs, tablets and smartphones. After its best quarter ever, Lenovo reported a few days ago that it continued to outgrow the market in all locations with record sales, pre-tax income and earnings..
Lenovo continues to breathe down the neck of Hewlett-Packard which, by a narrow margin, holds the position as the world’s leading PC manufacturer.
Behind the smog in China’s big cities, a silent revolution or shall we say e-volution, is underway. During 2012, China added 51 million new Internet users, giving the country 564 million internet users in total, according to China Internet Information Center. The number of Chinese people surfing the Internet from mobile phones, tablet computers and other wireless devices rose by 18 per cent last year to 420 million. We remain upbeat about the prospects for selected consumer technology and telecom players.
We have always been skeptical about claims that China has inflated a huge real estate bubble. As we have detailed before, China’s real estate market is very different from those in the US and Europe. First of all, prices in China have not risen as fast as Western observers may think when they visit the big cities in China, which account for only a small portion of this giant market. If you look at the entire Chinese residential real estate market, prices have actually risen more slowly than disposable income each year for the past ten years.
Secondly, Chinese home buyers typically use no or little bank financing when they buy their homes. Finally, unlike the situation in the US a few years ago, there is a huge demand as a result of the largest urbanisation of a population that the world has ever seen. Just a few days ago, statistics for the entire country revealed that the overall price increase per square metre last year amounted to 8 per cent. That is not a problem while disposable income in China continues to grow at a rate of 11 per cent.
The doomsday projections for China’s real estate sector are as regular as the winter flu and are bound to make headlines again this year and in the future. But before we face the next epidemic outbreak of bubble mania, more investors will come back to China, realising the real estate sector will perhaps not crash and bring the banks and the economy down with it. Other investors may come back into China thinking that after a few years of high growth and a lackluster stock market, it may actually be China’s turn to overperform.
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East Capital is a Stockholm-based independent asset manager focusing on Eastern Europe and China. It has about 4bn euros under management in both public and private equity.
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