China's slowdown: how worried should investors be?, February 2019

From Apple to HSBC, Jaguar Land Rover to Samsung, the warnings from companies around the world are growing in number: China's economic slowdown is beginning to have an impact on corporate profits.

The Chinese economy expanded by 6.6%* in 2018 - the weakest pace since 1990 - amid an intense trade dispute with the US, weakening domestic demand and alarming off-balance-sheet borrowings by local governments.

However, given this growth rate is still some 5% more than that of the UK economy, which grew by 1.4%* last year - the weakest it had been since 2009 – how worried should investors be?

We asked the Invesco Asian equities team what they make of the falling numbers.

A measured stimulus, not a global bail out

“China bailed out the global economy during the global financial crisis. Or at least that was the perception when China responded to the 2008 seizure in global trade with a 4 trillion RMB (US$600bn) stimulus package.

“The current slowdown is obviously not as acute as it was a decade ago, but economic indicators are clearly pointing down (job offers, inflation, exports growth, etc). Retail sales growth, although still positive, is also trending lower, suggesting that consumers are also feeling the pinch. This tallies with our conversations on the ground. So naturally the question is whether the Chinese authorities are about to unleash another sizeable stimulus or not.

“In our view this is unlikely, barring a crisis. Rather we would expect a flurry of supportive measures to help smooth out the domestic down cycle, similar to the precedent set in 2016 – when the economy slowed significantly. 'Fine tuning' measures have already been taken to support liquidity, including lowering the level of reserves banks must hold, and tax cuts have been announced to support small businesses and consumers. We would expect this to continue.”

Slowdown to some extent engineered

“It’s worth recalling that the Chinese authorities have effectively engineered this slowdown – clamping down on shadow banking in an attempt to control its total debt-to-GDP – debt that is mostly held at state-owned enterprises and local governments, not so much with the consumer or the central government.

“Also, tight property restrictions have been kept in place to keep speculators from pushing up prices. These seem to have worked, as credit growth is now in tune with nominal GDP growth, and affordability ratios have been improving. Reversing these achievements through a one-off stimulus would be self-defeating, potentially reversing years of modest, but significant, re-balancing towards domestic consumption (now 54% of GDP vs 48% in 2010).

“With regards to trade tensions with the US, we would expect some agreement in the short term. The weakening economic backdrop in the US is a strong disincentive to further elevate tariffs but, longer term, we expect further acrimony between the two economic powers.”

Finding contrarian opportunities

“Markets were quick to price in the current slowdown - China’s domestic stock market was one of the worst performing in 2018 - but pockets of opportunity have emerged, particularly in some of the worst performing sectors, namely autos and technology – both consumer related. 

“We have added exposure to China over the last 3 months but only marginally, and we remain underweight for the time being.

“In relation to the Invesco Asian fund, some stocks have recently caught our attention. We introduced Huayu Automotive Systems-A, the biggest auto parts supplier in China, which was good value in our view and has a dividend yield of 7%.

“We also added exposure to Baidu, the 'Google of China'. Whilst we hear the concerns about the sensitivity of advertising spend to China’s slowdown, and the increased competition for advertising spend generally, we feel that ultimately Baidu will be able to grow its search business in the long run. The company has tightened up its strategy and is returning to its core search business, which we believe it can leverage to grow, as it increases monetisation by employing newsfeeds and apps to increase reach, and as it develops machine learning and artificial intelligence to drive its emerging businesses such as cloud and voice.”

Important information
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. The Invesco Asian Fund (UK) invests in emerging markets, where there is potential for a decrease in market liquidity, which may mean that it is not easy to buy or sell securities. There may also be difficulties in dealing and settlement, and custody problems could arise. The fund may use derivatives (complex instruments) in an attempt to reduce the overall risk of its investments, reduce the costs of investing and/or generate additional capital or income, although this may not be achieved. The use of such complex instruments may result in greater fluctuations of the value of the fund. The Manager, however, will ensure that the use of derivatives within the fund does not materially alter the overall risk profile of the fund.

Past performance is not a guide to future returns. Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. For the most up to date information on the Invesco Asian fund, please refer to the relevant fund and share class-specific Key Investor Information Documents, the Supplementary Information Document, the Annual or Interim Short Reports and the Prospectus.


Published on 20/02/2019