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Source believes China is set to find favour again

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ETF provider Source believes that positive first quarter economic data from China suggests the market is set to once again find favour with investors in 2016. 

The firm writes that while first quarter GDP growth at 6.7 per cent was a touch below the 6.8 per cent of the previous quarter, the much feared collapse in China appears not to have occurred.
 
“Furthermore, in addition to evidence that the Chinese property market is recovering, there are signs that other parts of the economy are accelerating too, including growth of 10.7 per cent in investment spending, 6.8 per cent in industrial production and 10.5 per cent in retail sales. Even more impressive, aggregate financing was CNY6.5 trn in Q1, up from CNY4.6 trn a year ago” the firm says.
 
Paul Jackson, Head of Multi-Asset Research at Source, says: “There currently seems little enthusiasm for Chinese stocks among either foreign or domestic investors but that could quickly change. While the 43 per cent top-to-bottom decline in the FTSE A50 index during the June-August 2015 period could have been viewed as an opportunity, the manic stabilisation efforts of the Chinese authorities acted as a deterrent for many investors.
 
“Recent data flows suggest it is time to take another look. There are still lots of new initiatives but policy makers do not seem so panicked. The market is up 13 per cent since last year’s August low and has been making steady progress since the end of January.”
 
Paul Jackson says: “The easing by the PBOC has stimulated monetary growth, reduced bond yields and weakened the yuan, all of which should be supportive of local equities.”
 
From a valuation perspective, a cyclically adjusted price earnings ratio of 9.1 is as low as it has been over the period available. This is less than half the historical average 20.3 and well below the current US multiple of 25 (the emerging market average is around 12). This modest valuation explains why Source’s five year FTSE A50 target (17,000) is so far above the current level (9,723). That suggests an annualised five year return of nearly 12 per cent, even before dividends are included (the yield is close to 3 per cent).
 
Paul Jackson says: “The above calculations do not allow for what might happen when MSCI and other index providers include A shares in their emerging market indices. This will likely happen this year or next. A mid-year dip in the Chinese market would not be unusual; however, we would use that as an opportunity to buy equities even more cheaply.”

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