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Greater China Equities

Despite the dual threat from global recession and trade tariffs, Greater China Equities made strong gains in 2019. Investors were buoyed by targeted Chinese government support and a resilient earnings growth, particularly in the consumer and technology sectors. In this outlook, Kai Kong Chay, Greater China Specialist, looks ahead to some of the bright spots in 2020, including the much-awaited sales recovery in domestic industries, expanding opportunities in small-cap and mid-cap China A-shares and a technology resurgence in Taiwan.

2019 Review: Targeted government policies and resilient earnings

Amid periodic bouts of market volatility, Greater China Equities outperformed both emerging and regional markets1 in 2019. China and Taiwan led the way, with Hong Kong posting relatively moderate gains2.

Several factors contributed to these robust returns. The Chinese government offered notable fiscal and monetary support throughout the year, including tax reforms and consumer incentives3. This assistance helped to propel earnings in key sectors. Fundamentals for the consumer discretionary and technology sectors in Greater China benefited from broader trends, as the global technology upswing in the second half of the year helped to send tech shares in Taiwan sharply higher, outpacing already elevated market gains4

2020 outlook: Attractive valuations and new opportunities  

For 2020, we expect a similar macro environment to prevail in China, and with ongoing government support, we should see close to 6% growth. Also, if the economy stabilises enough, then firms should be able to resume maintenance capital expenditure – a move that we believe is not yet priced in by investors and would potentially boost our growth estimates. Sino-US trade tensions will continue to play a significant role in the market’s trajectory. We expect economic tensions between the two powers to remain a structural issue over the mid-term. 

Given reasonable valuations and improved corporate earnings, we will maintain our optimistic view of A-shares in 2020. We believe that valuations are attractive with a forward price/earnings (P/E) ratio at approximately 10-11 times5, which is inexpensive compared with Hong Kong and other global equities. The critical catalyst should be positive sales activity in the leading domestic sectors, such as home appliances, cell phones, and automobiles. If the hoped-for recovery materialises, then the market will continue the rally, albeit at a slower pace than in 2019. 

One of the key themes for 2020 will be the increasing opportunity set in Chinese equities: the inclusion of A-shares in global indices (MSCI & FTSE) accelerated in 2019 and is slated to continue in 20206. Investors should note that the latest additions will include small-cap and mid-cap stocks which we believe is the most inefficient segment of the A-shares market, and an area for active managers to exploit. This can potentially be a rich source of alpha generation that is currently unavailable to overseas investors. 

Only 30% of A-shares outperformed the index in 20197. As the earnings of numerous companies are expected to recover in 2020, we think that the A-share rally will be robust and comprehensive, with 50–60% of stocks expected to outpace the market index. Cyclical and growth names are likely to lead the way in the first half of 2020. 

Sector outlook: Rich opportunities in Greater China Equities

For several years, we have viewed the opportunities in the Greater China equities market through the prism of three themes: 1) Consumption upgrade; 2) Research and Development; and 3) Technology.  For 2020, we see the greatest opportunities in the following two categories: 

1) Consumption Upgrade 

Growing personal income has been a vital driver of the consumption upgrade theme in China. Even with a structurally slowing economy, disposable income in China has grown by approximately 54% over the past five years8. We now see stronger earning power and increasing retail sales across the lower-tier cities9. In fact, retail sales growth in fourth-tier and fifth-tier cities have outstripped those seen in first-tier and second-tier locations over the past year10

  • E-commerce platforms and apps: We believe that disposable-income growth across China and convergence between urban and rural incomes offer unique opportunities for e-commerce platforms and apps. Investors are aware of several successful e-commerce platforms and digital apps in the Chinese market. However, we feel that the growth prospects of these platforms have further to go as rural consumers come online. Of note, a large e-commerce platform recently disclosed that 70% of new active users came from third-tier and fourth-tier cities11. Food delivery and entertainment apps are also reporting a rise in user numbers. Moreover, online payment providers have revealed that over 60% of their new customers are in these lower-tier cities12.

2) Research and Development (R&D)

In R&D, our team views healthcare and technology equities as offering the best opportunities. 

  • Healthcare: We have been positive on healthcare in China for several years due to several key structural factors: an ageing population, increased purchasing power, and the rapidly emerging landscape for innovative drug discovery. Indeed, China’s pharmaceutical sector is likely to expand by a compound annual growth rate (CAGR) of 7.2% from 2017 to 2025, with the market for speciality drugs expected to grow even faster13. Industry consolidation and a more favourable regulatory environment should provide opportunities for pharmaceutical companies. With the United States Food and Drug Administration’s (FDA) recent approval of the first-ever cancer drug researched in China14, we believe that local pharma firms will continue to move up the value chain and distribute medicine products both domestically and abroad. We are in favour of companies that invest in the development of new and innovative treatments, particularly in the oncology space. Moreover, biotech currently accounts for only 5.7% of the total pharma market in China, so there is plenty of room to ramp up to a global penetration level of over 26%.

3) Technology

We are also constructive in tech. Taiwan’s equity market has performed strongly in 2019, and we believe that tech support will continue in 2020. Taiwan’s electronics suppliers have benefited from the trade tensions between the US and China, and this position of “substitution” should remain, as they can supply both US and Chinese electronic manufacturers. In addition, Taiwan should be supported by a rebound in server sales, new and cheaper electric vehicle models, amplified demand for new smartphone models, and the accelerated rollout of 5G. 

Undoubtedly, 5G should be a prominent theme in the A-shares space, as the cell phone replacement cycle in mainland China is expected to shrink from 24 months to its historical average of 15–16 months. We are constructive on battery producers, chips, frequency, and antenna-related industries. 

Last but not least, we remain focused on policy-driven opportunities and are constructive in areas of environmental protection, such as natural gas distribution and some waste-to -energy companies. This stance is based on long-term support from the government.  

Conclusion

All in all, we believe that favourable conditions are in place for Greater China Equities to deliver attractive returns in the coming year: fiscal and monetary policy should continue to ease at the margin and recovery in sales could lift the profits of domestic firms. We also have opportunities from secular trends and the internationalisation of the China A-shares market. 

Still, we will be watching investment and consumer sentiment closely, as these are leading indicators of China’s future economic trajectory. We will also assess whether companies increase their regular capital expenditure in response to any trade agreement. Lastly, the Chinese government’s targeted fiscal and monetary policy measures will continue to play a crucial role. 

Kai Kong Chay, Greater China Specialist
  1. Bloomberg: MSCI Zhonghua posted a 14.50% gain, while MSCI Emerging Markets was up 12.56% and MSCI Asia-Pacific higher by 13.33%. Indices are total return and denominated in US dollar, as of 25 November.
  2. Bloomberg: MSCI Taiwan rose by 31.94%, MSCI China was higher by 16.32%, and MSCI Hong Kong was up by 8.35%. Indices are total return and denominated in US dollar, total return through 25 November 2019.
  3. Reduce value-added tax on companies and lower social security contributions for employees; decrease individual marginal tax rates to stimulate consumption; offer consumption incentives for autos and electronics.
  4. Bloomberg, the information technology segment of the MSCI Taiwan Index rose by 39.61% through 25 November 2019. 
  5. FactSet; as of 30 November, 2019. Predicted 2020 PE ratios of MSCI China is 11.5 times, lower than 14.1 times of the MSCI Hong Kong Index and 16.5 times of the MSCI World Index.
  6. Chinese A-shares will compose roughly 3.3% of MSCI Emerging Market Index’s at the end of November, FTSE announced to Include 25% of A-shares (~1000 names) in 3 steps (Jun 2019 -Mar 2020).
  7. Bloomberg. As of November 18, 2019. Among the 319 constituents of the CSI 300 Index, 99 listed firms (31%) outperformed the index, which rose 29.8%. Return calculations based on share/index prices in local currencies. Past performance is not indicative of future performance.
  8. National Bureau of Statistics of China, as of 21 January 2019.
  9. A lower-tier city is defined as a third, fourth or fifth tier city.
  10. National Bureau of Statistics of China, as of 30 September 2019
  11. “The Rise of China’s Smaller Cities”, Cheung Kong Graduate School of Business, 26 June 2019.
  12. Questmobile, data, as of 30 September 2019.
  13. “SC Imago Journal & Country Rank”, Citi Research, as of December 2017 and Citi Research, SCMP, as of August 2019.
  14. “China's BeiGene gets FDA approval for drug to treat rare form of lymphoma.” Reuters, 15 December 2019. 

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The VHIS Office recently discovered a translation error in the Chinese version of the Schedule of Surgical Procedures of the Certified Plan Policy Template. In the fracture/dislocation section of the Surgical Schedule, “clavicle” on the 8th and 12th items was mistranslated as “scapula” and “scapula” on the 13th item was mistranslated as “clavicle”. Manulife has reviewed and revised the relevant product information of Manulife’s VHIS certified plans upon the VHIS Office’s request, and has revised the Chinese version of the certified plans’ policy provisions accordingly. The English version of the policy provisions is not affected. For any enquiries, please contact Manulife’s service hotline at 2108 1188.

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The VHIS Office recently discovered a translation error in the Chinese version of the Schedule of Surgical Procedures of the Certified Plan Policy Template. In the fracture/dislocation section of the Surgical Schedule, “clavicle” on the 8th and 12th items was mistranslated as “scapula” and “scapula” on the 13th item was mistranslated as “clavicle”. Manulife has reviewed and revised the relevant product information of Manulife’s VHIS certified plans upon the VHIS Office’s request, and has revised the Chinese version of the certified plans’ policy provisions accordingly. The English version of the policy provisions is not affected. For any enquiries, please contact Manulife’s service hotline at 2108 1188.

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