Can China survive a hard landing?

31 July 2012 | By Gary Jackson

China has long been a driver of global growth and has cemented its position as the world’s second-biggest economy but the country’s well publicised slowdown threatens investor sentiment.

The most recent data shows the Chinese economy grew by 7.6 per cent in the second quarter of 2012. Although this pace would be envied by most countries, it is a fall from 8.1 per cent in the first quarter and well below China’s historical growth rate of about 10 per cent.

The main fear surrounding China is the so-called hard landing – a rapid slip in growth that would be considered to have occurred in China should GDP expand by less than 7 per cent. Recent indicators such as the trade balance, inflation and manufacturing output have dipped but the market consensus is that the country will be able to engineer a soft landing.

Earlier this month, the International Monetary Fund cut China’s 2012 growth forecast to 8 per cent, down from the 8.2 per cent it predicted in April. The Washington-based lender also said a hard landing is possible but this is not the base scenario.

Fitch Ratings also predicts that the country will avoid a hard landing. However, it warns that the reliance on fixed asset investment to stimulate growth in the short term is not sustainable.

So, given the backdrop of a weakened growth outlook and a need to move away from a major traditional source of stimulus, where are investment opportunities being found in China?

On an asset allocation level, fund managers’ sentiment towards China has improved recently. Bank of America Merrill Lynch’s July survey shows managers are less worried about the economy’s slowdown but have yet to return to their past all-out confidence.

BofA ML head of European equity strategy Gary Baker says: “The big call for anyone is what you do with China. Views on the Chinese economy have stabilised but I would not say they are wildly optimistic. They are just in the neutral zone at this point.”

HSBC global head of macro and investment strategy Philip Poole points out the Chinese stockmarket looks cheap relative to its own trading history.

He says: “Clearly, there has been a lot of negative momentum for the Chinese market and we have seen it underperform for some time. But we see that more as an opportunity for investors who can take a longer-term view.”

Poole claims opportunities can be found in companies benefiting from the Chinese government’s use of infrastructure investment as a source of short-term stimulus. However, he stresses that this is not a long-term play, it is likely to last only six to 12 months and is highly dependent on how economic indicators change over the coming months.

Thames River emerging markets manager Michael Sell adds that the rise of the Chinese consumer is another source of investment ideas and one which looks set to last into the medium to long term.

Sell, who manages the £8.2m Thames River Emerging Asia fund and the China portion of the £115.2m Thames River Global Emerging Markets fund, highlights department stores Golden Eagle and Parkson as well as footwear retailer Belle as attractive holdings.

He says: “It used to be that Chinese consumer stocks were very expensive versus their peers globally and regionally but that is no longer the case. If you believe the Chinese consumer will continue to be strong over many years then you are getting these stocks at very attractive valuations.”

Poole also offers China’s move towards urbanisation as a longer-term theme to sit alongside consumption.

After short-term infrastructure investment has ended, the country will still develop its cities further and create new ones entirely as citizens continue to move from rural areas to urban destinations, Poole notes. This could create investment opportunities such as construction, materials and telecommunications.

Hargreaves Lansdown investment analyst Richard Troue says investors are still interested in China despite the headline fears of a hard landing. He says: “It is something that has to be viewed with your long-term hat on especially while the eurozone crisis is rumbling on, which is going to affect China.”

Troue agrees that consumption and urbanisation are attractive themes but warns that the retail investor should not have too much exposure to shorter-term plays on infrastructure-based stimulus.

He adds that China’s latest five-year plan, which includes measures to rebalance the economy and boost social provisions, can create even longer-term plays on the country’s growth. He cites Philip Ehrmann, whose £171m Jupiter China fund has been investing in healthcare and sustainable technology firms, as a manager looking to capitalise on the country’s reforms.

Skerritt Consultants head of investments Andrew Merricks (pictured) agrees that retail investors continue to be attracted to the Chinese growth story. However, Skerritt does not invest directly in the country and has recently been cutting back exposure to emerging markets, natural resources and other beneficiaries of China’s expansion.

He says: “The Chinese expansion is an irreversible beast but we are reducing exposure at the moment because it is not the gung-ho story it was previously.”

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