China appears enticing

With valuations attractive after falls last year, Chinese equities display promising potential. Stocks in the world’s second-largest economy are benefiting from economic growth bottoming out at healthy levels, now that the country has reversed its tightening of monetary policy.

In general, equity is one of few liquid asset classes that promises to grow and counter inflation’s negative effect on investment or retirement portfolios over the long term. Relative to their peers, emerging market equity valuations look especially compelling. As a multiple of their tangible assets minus their liabilities – in other words, on a price-to-book basis – they are trading in the lowest quartile of their range in the past 10 years. As a multiple of their earnings, they are also valued at a 17 per cent discount to developed world stocks.

Chinese equities have underperformed global, as well as Asian, equities since the end of 2009, mostly due to monetary tightening and fears of a hard landing induced by the policy measures. These fears are gradually fading, and Chinese equities are trading at very attractive valuations, both on an absolute basis as well as relative to their own history. For this reason, China represents one of the most attractive opportunities within the wider emerging market remit.

The outlook for the renminbi also looks positive over the mid to longer term, based on the currency’s fundamental undervaluation. This undervaluation is expected to decrease over time, with the renminbi rising against the dollar. Based on a broad range of analysts’ expectations, the forecast for 2012 is an appreciation in the renminbi of 1.5 per cent to 3.2 per cent.

The economic backdrop in China is also improving. As a result of the large fiscal stimulus of 2008/09, inflation started picking up in 2010. Property prices increased very sharply. As a countermeasure, the Chinese government tightened monetary conditions significantly, and introduced several measures to cool down the property market.

While this took its toll on economic activity and the equity markets, latest data indicates that the Chinese economy is heading for a soft landing and likely to find a bottom in the first half of 2012. A modest fiscal easing is widely expected this year, with government priorities focusing on public housing, completion of ongoing infrastructure projects, small to medium enterprises, services and consumption. On the monetary side, there will most likely be gradual cuts in the reserve requirements for banks to inject liquidity into the economy.

During the annual Central Economic Work meeting (December 12-14 2011), the government maintained its economic objective of “striking a balance among stable growth, structural adjustment and inflation control”. In this context, stimulating domestic demand, particularly consumption, is a priority. Policymakers are highlighting the importance of maintaining appropriate investment scale, for example in railway infrastructure or agricultural irrigation, while ensuring the financing demands of existing projects.