2017 outlook: China equities

What lessons have you learned from 2016?

The Communist Party continues to tread a path that blends the competing needs of growth, reform and deleveraging as well as micro-managing the economic cycle. Considerable policy debate must be raging behind closed doors and between differing ideologies at the top of the Communist Party. We also learnt that investor positions in Chinese equities are very low as many clients expressed considerable surprise at the resilience of the Chinese economy and equities through the year.

What are the key themes likely to shape the markets in which you invest in 2017?

In the fourth quarter of 2016 the Communist Party Plenum will mark the end of President Xi’s first five-year term and the beginning of his second, and final, five- year term. Consequently, much of 2017 will be spent ‘reading the tea leaves’ of policy and the next generation of Party leaders that will be promoted to the Standing Committee of the Politburo in November 2017. At that point we will see just how tight President Xi’s grip is on the Party and the economy.

The battle between expensive growth stocks exposed to the ‘new economies’ in China and the value stocks in the ‘old economy’ will continue. We believe China portfolios will continue to find attractive pockets of value in the domestic A share markets and investors will begin to realise that bank shares are ‘value traps’ to be avoided.

At the macroeconomic level we need to watch the physical property market, which looks ‘bubbly’ and the Chinese currency, which is likely to continue depreciating against the US dollar. Investors may panic (again) that the Communist Party will not be able to manage a gradual depreciation.

What are your highest conviction positions moving towards the new year?

We have a blend of top quality growth stocks exposed to long-term trends such as mobile internet and life insurance, including Alibaba, Tencent, NetEase and AIA Group. We are also investing in more cyclical value stocks where return-on-equity may have bottomed and is set to improve such as Daqin Railway. While we are less bullish on auto shares, we are still positive on BMW’s joint venture partner Brilliance China and steering systems supplier Nexteer.

What should investors expect from your asset class and your portfolio(s) going forward?

The asset class will certainly experience more volatility and predicting markets is foolhardy. But we believe our portfolios that are significantly underweight financials, with no banks, have the potential to perform well. Our focus on the best companies with strong cash flows still appears appropriate in an economy that muddles through just as it has done in recent years.

The Chinese equity investment case may not always be easy to appreciate but we hope that investors will begin to recognise the opportunities available at a stock level despite the macroeconomic challenges.