BlackRock’s Investment Institute has published a report on China’s economic growth, entitled “Climbing China’s Great Wall of Worry – Investment Risks and Opportunities”. The report finds that the growth model is looking out of date, debt is piling up and capital outflows are rising.
The report says: “The growth formula that worked so well in the past is at the end of its shelf life.”
Helen Zhu, Head of China Equities at BlackRock, says: “Despite slowing growth in China, recent structural reforms in the economy and capital markets have boosted the performance of China’s equity markets. Rising valuations mean it is increasingly important to be choosy. There are warning signs that some pockets of the A-share market have become overheated, but we are seeing attractive investment opportunities in selected banks, property developers, new energy and small-and medium-sized companies in the H-share market. Companies that benefit from domestic demand and structural reforms will be the winners.”
Neeraj Seth, Head of Asia Credit at BlackRock, adds: “China, the world’s third largest bond market, is undergoing a significant transition. Emergence of the municipal bond issuance under the debt swap and increase in corporate issuance continues to change in market structure of the onshore fixed income markets. There is also significant issuance in USD and CNH (Dim sum) markets from Chinese issuers. Despite some risks and transparency issues, opening up of Chinese fixed income markets provide attractive opportunities for fixed income investors, especially in municipal bonds and selectively in corporate credit. Additionally, Chinese USD credit and dim sum bonds also provide opportunities for the regional and global investors.”
The report recognises that China’s economy is slowing, likely by more than official statistics indicate. “Yet we do not expect an economic hard landing or financial market crash in the short term. This is reflected in our overweighting pro-cyclical investments – an implicit belief that China’s economic miracle will last a bit longer.”
The four trends that most influence BlackRock’s investment strategies and thinking are: China’s reining in runaway credit growth; the shift toward a services economy; the risk of a property market downturn; and the government’s ability to stimulate the economy in the near term.
“Many of us believe China can meet these challenges in the short term, with some hiccups along the way. Policymakers appear aware of the risks, and have credible long-term plans (an ambitious reform agenda) and short-term tools (room for monetary and fiscal stimulus) to address them” the report says.
China has contributed more than a third of global economic growth since 2008-2009, and its current slowdown is reverberating around the world. “Officials are keenly aware of the dangers of debt rollovers by state enterprises and local governments. They appear confident they can avoid a credit crunch, in part by converting short-term, high-interest local government loans into municipal bonds with longer maturities and lower coupons.”
The firm predicts that the People’s Bank of China (PBoC) will further cut interest rates and historically high bank reserve ratios in an attempt to reignite growth. “The government also appears ready to prop up property prices and support the construction industry by investing in infrastructure at home and abroad” the report says.
China has committed to opening its capital account by year-end, but BlackRock finds it is unclear what exactly ‘open’ means. “The risk of capital flight will likely make the country tread carefully, and we do not expect a truly free-floating yuan currency any time soon. Policymakers’ focus on currency stability should anchor the yuan for now.”
Investors should think of China as a continent, not as a country, the report urges. “Economic trends, development and policy implementation vary greatly by region. The economy is slowing in the Northeast (heavy industries) and West (mining) but is still going strong in the densely populated and prosperous coastal areas.”
While it is tempting to simply dismiss buying Chinese assets on the grounds that there is too much debt, too little growth and too policy-driven, the firm believes that this is a mistake. “One can worry about the economy and rising risks in the long run but be bullish on markets in the short to medium term.”
China’s domestic equity markets look frothy after more than doubling in 12 months and BlackRock prefers less expensive Hong Kong-listed Chinese equities, especially small- and medium-sized stocks, because they have suffered a liquidity discount that is set to dissipate. “We like selected corporate bonds in offshore markets because of their relatively high yields and limited duration risk.”