2019 was a challenging year in which we saw a material slowdown in China’s economy. Much of this weakness reflected the tougher external environment caused by US-China trade tensions, and the effects of the government’s previous efforts to rein in systemic risks in the economy. In particular, the crackdown on excess debt and efforts to control property prices in 2018.
We expect China’s economy to stabilise in 2020. This should be underpinned by a combination of easing monetary conditions as the central bank introduces measures to improve the availability of credit, greater fiscal support through the government’s tax and spending policies, and potentially a bottoming in global industrial activity. Some form of trade deal with the US should also help to support a modest reacceleration in growth over the course of the year.
Why we think there is more stimulus to come in 2020
2020 represents the final year in China’s 13th five-year plan which, among other goals, aims to build a “moderately prosperous society”. One of the key targets of the plan is to double the country’s GDP between 2010 and 2020. To achieve this, China will need to deliver GDP growth in the region of 6% next year.
Today, Chinese policymakers are putting greater emphasis on managing longer-term risks in the economy, as evidenced by the more measured stimulus introduced so far. However, we think that some additional easing will be needed to support economic growth over the next 12-months, given the challenging external environment and soft domestic economy.
What form might stimulus take?
On the monetary policy front, we expect continued easing in the form of reserve requirement ratio (RRR) cuts for banks, and a lowering of the Loan Prime Rate (LPR). RRR is the percentage of deposits that the government requires banks to hold in reserve, while the LPR is a lending rate calculated by National Interbank Funding Centre, a branch of the People’s Bank of China (PBOC), based on quotes from a panel of banks.
Interest rate cuts (repo rates) will be more challenging to execute, at least in the first quarter, due to the uptick in inflation from rising pork prices. In terms of credit, we may see some loosening by the banks. But, as we have seen over the past 18 months, the PBoC will need to continue to strike a balance between supporting economic growth and de-risking in the shadow-banking sector.
We expect the government will lean more on fiscal policy in 2020 to help stabilise growth. Overall fiscal spending in 2019 has been disappointing. We believe that the more recent pickup in special purpose bond issuance and infrastructure spending in the second half of 2019 will likely continue in the first half of next year. We may also see the government raise its budget deficit (whereby government spending exceeds revenues) target towards 3% of GDP (from 2.8% in 2019) to fund more infrastructure investment in 2020. The outlook for investment in other sectors is more uncertain, given the overhang stemming from US trade relations and a potentially softer housing market.
We expect the government to continue to push capital market reform, as it looks to encourage investment, as well as household registration, or Hukou, reform to help support the property market and consumption. However, on the property front, we do not expect to see any significant loosening in policy given the repeated emphasis that “housing is for living in, not for speculation”.
Which areas of the economy will drive growth?
Consumption has done much of the heavy lifting in terms of supporting growth this year, and we expect this trend to continue in 2020, underpinned by a number of factors. Employment growth remains solid, with close to 12 million urban jobs created in the first 10 months of the year, while disposable incomes increased by +6% in 2019 in real terms. Savings rates are still high in a global context while demand for unfulfilled services (i.e. healthcare) is rising. Furthermore, new business models driven by technological disruption, and supportive policy measures (i.e. personal tax cuts) are also likely to be beneficial.
In terms of private investment, we could see a moderate pickup in manufacturing investment and capital expenditure, as credit conditions ease for small and medium-sized enterprises (SMEs) and profit expectations improve. However, this outcome is less certain.
On the trade front, it is clear that the scope of tensions between China and the US has expanded beyond trade and into other strategic areas such as technology and capital markets. Our base case remains that tensions between the two sides will be a drag on investment and global growth in the coming years.
That said, China’s response has been to emphasise greater ‘self sufficiency’ in terms of technology and its growing effort to support companies in strategic industries (i.e. aerospace, IT, semiconductors, robotics). We believe that there will be some attractive opportunities for investors as “national champions” begin to emerge.
Valuations are below average and earnings look set to pick up
We believe that the negative earnings revisions we have seen in the last 18 months are close to bottoming. We expect a more stable, mid-to-single digit increase in year-on-year growth in 2020.
With valuations for the overall MSCI China Index slightly below their long term average, we may continue to see liquidity support from Southbound flows (to Hong Kong SAR from mainland China markets). Flows towards China A shares, on the other hand, may be more mixed as the latest round of MSCI Index inclusion changes has now been completed and the timing of further weight increases is unclear.
Where are the opportunities in China’s equity markets?
Against this backdrop, we are adopting a balanced approach across our China focused strategies. We remain focused on domestically-oriented businesses, which we believe will benefit from China’s medium term growth story. Our preference is for consumer companies with exposure to the consumption upgrade theme, renewable energy, pharmaceuticals, insurance and select TMT/internet/5G plays.
You can read and watch more from our 2020 outlook series here
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