China’s commitment to the official 7 per cent growth target was demonstrated this past week when the People’s Bank of China (PBoC) made a full percentage-point cut to its reserve requirement ratio (RRR) – a bigger move than what was expected, says Alan Higgins, UK CO for Coutts…
We see more cuts to the RRR and/or deposit and lending rates to come in pursuit of that target. Unlike many other central banks, China has room for more rate cuts should economic conditions warrant them. We believe this policy support gives Chinese equities room for further gains, supporting our positive view on China.
The immediate reaction to the RRR cut has been limited in the currency markets, with the offshore renminbi little changed against the US dollar. Large or sustained sell-offs in the Chinese currency are unlikely and we still see scope for some modest appreciation against the dollar. Recent weak data had been strengthening the case for PBoC easing. Last week’s data on gross domestic product showed the economy growing at a slower-than-expected annualised pace of 5.2 per cent in the first quarter. Slowing credit growth, trade, industrial output, retail sales, fixed asset investment and foreign direct investment all weighed on first-quarter growth.
China’s latest rate cut came two days after the China Securities Regulatory Commission (CSRC) announcement of tighter margin lending rules for certain brokers and set limits for riskier small-cap stocks traded over the counter. Investors in China should be prepared for bouts of volatility as authorities continue to look for ways to curb speculative activity, or “clean up” the financial system.
However, these measures are aimed at promoting better transparency and ultimately a better quality of growth. The continued balancing act of implementing reforms and providing monetary stimulus to prevent a widespread economic slowdown should lead to slower but stable growth in China, which we believe bodes well for long-term investment.
More value in Hong Kong listed Chinese equities
H-Shares – Chinese equities listed on the Hong Kong stock exchange – have returned over 20 per cent so far this year, lagging the almost 34 per cent gains in China’s mainland Shanghai-listed A-shares. We continue to see the H-shares as more attractively valued, trading at a price of nine times 2016 earnings estimates, whereas the A-shares trade at 15 times 2016 earnings estimates.
We believe there is ample scope for Asian equities to recover lost ground against developed markets as global investors become increasingly attracted to the region’s improving outlook. Although global valuations in general have trended closer to their long-term average, Asian (and European) equity valuations are relatively attractive and we also see the potential for earnings recovery as greater.
Going for quality in emerging-market bonds
Local-currency emerging-market bonds continue to generally lag the gains seen in their dollar-denominated counterparts, amid currency depreciation and mixed economic data. Russia has been an exception recently, as geopolitical risks have abated and the rouble has made a remarkable comeback. On the other hand, Brazil remains out of favour amid weak growth and rising inflation. We continue to see dollar denominated, higher-quality emerging market government and corporate bonds as among the most attractive within fixed-income markets. These bonds have some of the best risk-adjusted return potential in our view, but we generally remain cautious on local-currency emerging market debt.