The mid-November activation of the Shanghai–Hong Kong Stock Connect, which links the equity markets in those cities and allows investors in one location to trade on the other exchange, has many fund managers excited again about Chinese equities.
“We see this as a big leap forward for China,” affirms Lennie Lim, Singapore-based head of Legg Mason Global Asset Management for Asia ex-Japan. “We see this as increasing opportunities for investors on both sides, and we in turn are trying to provide more access for our global clients to China’s markets.”
Those on the sell side echo that view. “In preparation for the Shanghai–Hong Kong Stock Connect launch, we expanded our team and our coverage universe,” explains Vincent Chan, head of China research at Credit Suisse in Hong Kong. “We increased the number of Chinese companies under our coverage by more than 50 percent, to nearly 300.”
Hong Kong–based Angello Chan, who oversees reporting on Chinese equities at Bank of America Merrill Lynch, says his firm is seeing “substantial interest among global investors in China in light of different industry reforms and corporate restructuring, including the commencement of the Shanghai–Hong Kong Stock Connect trading program.” He manages a team of 70 analysts who cover both Hong Kong–listed H shares and mainland-listed A shares, he adds.
This renewed focus comes at a time when Chinese stocks are rebounding after a disappointing 2013. The CSI 300, an index that tracks China’s largest Shanghai- and Shenzhen-listed companies, by market capitalization, bolted nearly 21 percent in the first 11 months of the year. During the same period, the S&P 500 advanced about 12 percent.
Naturally, investors are eager to participate in this resurgence, and many look to the sell side for assistance in finding winning investments. The analysts who provide the most helpful guidance, they say, can be found at China International Capital Corp., which leads Institutional Investor’s All-China Research Team for a third straight year. The firm captures 25 team positions, the same number as last year and 11 more than BofA Merrill, which repeats in second place. The U.S. bank claims 14 spots, two fewer than in 2013. Credit Suisse climbs one level, to No. 3, but that modest rise belies the organization’s robust gains: Its team total nearly doubles, from six positions to 11 — a feat bested only by fellow Swiss bank UBS, whose total vaults from three to ten. It rockets from ninth place to fourth and is this year’s biggest upward mover. Rounding out the top five is Morgan Stanley, which rises one rung after increasing its team total by three, to eight.
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These results reflect the opinions of nearly 850 investment professionals at some 410 institutions managing an estimated $584 billion in Chinese equities. For more information, click Methodology.
Many market observers are upbeat on China’s prospects for the year ahead. “We remain positive and expect domestically favorable catalysts to continue to unfold,” says Hong Liang, director of research at CICC in Beijing. Her firm employs 68 analysts who follow some 800 Chinese companies, up from 685 a year ago.
In late November the central bank reduced its one-year lending rate by 40 basis points, to 5.6 percent — a move that helps to reduce tail risks and encourages more risk taking from market participants, she notes. The surprise rate cut sent global equity markets soaring.
“Ongoing structural reforms will become much broader and more comprehensive, reinvigorating China’s longer-term growth potential,” Liang adds. “Current subdued valuations mean Chinese equities are still an attractive ‘sweet spot’ among global markets, with ample room for further rerating.”
Investors would do well to increase their exposure to “cyclical sectors and quality consumer names with solid growth visibility and reasonable valuations,” Liang believes. “Specifically, we would overweight financials — real estate, banks, insurers and brokers — among the ‘old’ plays, and health care in the ‘new’ space.”
China’s economy has undergone a painful restructuring since President Xi Jinping and Premier Li Keqiang came to power nearly two years ago. Xi unleashed an anticorruption campaign that has led to the punishment of more than 180,000 officials, and Li has stepped up support of China’s private sector, exempting businesses with monthly sales of less than 30,000 yuan ($4,800) from certain taxes while increasing bank lending to small and medium enterprises. Real gross domestic growth has slowed from 10.4 percent in 2010 to 7.7 percent last year, a downward trend that many economists believe is likely to continue.
“We expect GDP growth to moderate slightly from this year’s 7.3 percent to 7.2 percent in 2015,” says Ting Lu, the top-ranked economist for a second year running. Still, the BofA Merrill researcher believes that there are some short-term factors that might favor growth. The anticorruption campaign is unlikely to have a negative impact in 2015 as the government shifts its focus to economic expansion and institution building, he says, and the property market — which suffered a big downturn this year — will recover to some extent. “Balancing the long-term downward trend in potential growth and better cyclical factors, we expect only a moderate slowdown in 2015,” says Lu, who is headquartered in Hong Kong.
Not all sectors will be affected equally — or at all. CICC’s Xin Yang, the No. 1 analyst in Infrastructure & Transportation for a fourth consecutive year, maintains that many companies in her coverage universe will continue to do well.
“Despite China’s slowdown, the fast expansion of the Internet will boost the logistics sector, and the recent fall of oil prices is good news to the airlines,” she says. “Container terminals will enjoy the continuous rebound of exports as well.”
Among the Beijing-based researcher’s top picks of the past year is China Merchants Energy Shipping Co., which she upgraded from hold to buy in March on the belief that the company would benefit from rising demand owing to falling energy prices, among other considerations. The shares soared more than 92 percent through November.
“We still hold a positive view about the stock, given that there is significant improvement in demand-supply conditions in the oil tanker market, especially in the very large crude carriers — hence a freight rate hike is expected,” she says.
Telecommunications is another sector with ongoing growth opportunities, according to BofA Merrill’s Xinnian (Sydney) Zhang, who climbs from second place to savor his first appearance at No. 1.
“We are bullish on the China telcos because the government is driving all telcos to improve efficiencies and returns,” the Hong Kong–based analyst reports. Many of these companies are trading at less than four times their estimated fiscal 2015 earnings, which is significantly lower than the average of their Asian peers, he points out.
In mid-July, Zhang upgraded China Mobile from neutral to buy, at HK$77.36, after the State-owned Assets Supervision and Administration Commission ordered telecommunications services providers to reduce spending on advertising and marketing; the cutback should help boost the Hong Kong–headquartered outfit’s net profits, the analyst argued. By the end of November the stock had bolted 23.5 percent, to HK$95.55. “Our stock call on China Mobile has been among the most-read research by our clients,” he says.
Zhang’s colleague Wai (Eddie) Leung, who leads the Internet lineup for a third straight year, says rising demand for mobile data has given rise to significant upsides in investing in Chinese Internet companies. The momentum for online services — especially in demand for e-commerce — will continue to grow for quite some time, the Hong Kong–based analyst insists. His top recommendation remains search engine operator Baidu, whose shares advanced 38 percent in the first 11 months of the year.
Although the rapid rise in online retailing has hurt brick-and-mortar businesses as well as cut into demand for shopping centers and commercial real estate, opportunities still exist in the longer term in Consumer/Discretionary companies because China’s middle class will continue to grow, observes Chen Luo, who jumps from third place to the top of the sector roster.
“From a cyclical perspective, we believe the earnings will stabilize or even improve in the next 12 months,” he says. Oversupply in existing inventories will decline, and the anticorruption program, which cut into high-end spending on luxury products, will likely subside, believes the analyst, who is stationed in Singapore.
Luo’s top picks for the year include Belle International Holdings, a Shenzhen-based manufacturer and retailer of women’s apparel and shoes. “Despite the weak retail environment, we have argued that the recovery of its sportswear business and resilient footwear margins — thanks to a strong supply chain — could provide potential earnings upside in 2014, and its recent [fiscal] first-half result has reaffirmed our view,” he says.
In late October the company reported that net profit had surged 7.6 percent, to 2.08 billion yuan ($339 million), from March through August. By the end of November, the stock had advanced about 23 percent since bottoming out in March; year to date the shares are up 1.4 percent.
UBS’s Yanyan (Christine) Peng, who shoots straight in to first place in Consumer/Nondiscretionary in her first appearance on the team since 2010, also believes a turnaround is imminent. Her sector dropped about 20 percent in the year through November. “Hence we are turning more positive in the next 12 months compared with the beginning of the year,” she notes.
Even so, the Hong Kong–based analyst acknowledges there are challenges ahead, especially given the fact that the lead players already enjoy dominant market shares and will have a difficult time consistently outperforming in the future. She also believes that some companies are underinvested in their brands and products, which means that new product innovations might not be able to come through as easily and quickly as investors desire.
These and other concerns help explain why BofA Merrill’s David Cui, on top in Portfolio Strategy for a fourth year in a row, is less optimistic than many other analysts. “I hold a cautious view on China’s equity market outlook over a one- to two-year horizon,” he says. “I expect China’s financial system to experience turbulence at some stage as growth slows and bad debt increases.”
Investors should position their portfolios to withstand the coming volatility, adds Cui, who works out of Singapore. “I advise clients to be defensive, as China may potentially be going through an asset deflation cycle,” the strategist explains. Specifically, they should underweight financials, real estate developers and such investment-driven sectors as building materials, capital goods and contractors, he says, and overweight telecom, gas, utilities, defense, and some service sectors, such as logistics and tourism.
