The Chinese central government has been shifting its stance from an expansionary bias to a tightening bias in the past few quarters. Moving forward, it looks like China will continue to implement a tightening monetary policy. How can investors navigate through the new stance from the Chinese central government?
Recall back in 2016, the economic rebound in the Chinese economy was primarily driven by aggressive monetary easing that drove down the cost of financing. This was seen from the Monetary Conditions Index which combines the effect of interest rate, exchange rate and credit growth. The Monetary Conditions Index turned higher in that period, which represents easing bias.
However, since November 2016, the indicator has been turning downwards, driven by higher interest rates and net liquidity withdrawals. This is despite the Chinese economy achieving renminbi stability and reducing capital outflow. UOBKH believes that the tightening will have a negative impact on growth moving forward.
Chinese macro economy not in the best shape
While Chinese macro data had surprised on the upside since 2H16, especially for PMI surveys and inflation data, UOBKH has raised concerns that China’s economic growth may have peaked. Furthermore, the economic rebound since 2H16 was driven by inventory rebuilding, rather than true economic growth.
Citing the Caixin PMI, UOBKH analysts noted that it fell to 52.1 in March 2017 from 52.6 in February 2017 as the decline in new business sub-component took effect. March Purchasing Power Index (PPI) inflation data also showed a decline of 0.2 percent to 7.6 percent.
Growth unlikely to be sustainable in light of tightening bias
Some analysts have questioned whether the stronger growth established since 2H16 will help the market to survive through the policy tightening. According to UOBKH, the current rebound is mainly driven by rising interests in fixed asset investment and credit growth. Retail sales were also supported by favourable tax policies.
UOBKH believes that the economic situation is similar to that of the economic rebound in 2009-10. This makes the sustainability of the growth highly sensitive to monetary tightening.
Investors takeaway: Two investment plays to explore
1. Value Plays
As economic growth momentum slows, UOBKH opines that EPS growth upgrade cycle will also slow down. This will result in a change in investment style performance, whereby value stocks are likely to outperform growth stocks.
Historically, growth stocks have only outperformed value stocks at the tail end of a market rally. As of now, based on the MSCI universe, growth stocks have risen 19.0 percent year-to-date (YTD) against 9.6 percent YTD return for value stocks. It is a forewarning that value stocks are set to outperform in the coming months.
Thus, UOBKH recommends turning the focus to stocks that are undervalued, i.e. stocks that are trading 1.0x standard deviation below its mean Price/Book (P/B). While there aren’t many choices, UOBKH recommends looking at the following stocks for an undervalued play.
2. Growth Adjusted Value Plays
Another play that UOBKH recommends is to look at companies with better growth adjusted valuation. Using factors modified from MSCI’s definition of value and growth, UOBKH highlights companies that show relative value with above-average expected earnings growth outlook.