Richard Gao, a longtime portfolio manager at Matthews Asia, says investors need to understand the backdrop to––and consequences of––the changes in China’s growth pattern as the government emphasizes quality rather than quantity of economic growth. “We expect the 9% to 10% topline GDP growth from the recent decades to be more like 6% to 7% going forward,” Gao says in an interview. “Along the way, we’ll see slowdowns and some negative impacts from this general rebalancing of the economy.”
As lead manager for the Matthews China and China Small Companies funds, Gao says he and his team are focused on consumer-oriented names among automakers, department stores, supermarkets and dairy producers, along with service-oriented sectors such as education, health care, leisure and tourism.
Gao also sees opportunities in Internet-related companies engaged in e-commerce, online gaming and mobile services. Leading Internet-related names including Baidu and Tencent Holdings, both large holdings at Matthews, have zoomed during the past year, while investors are licking their chops over this year’s anticipated initial public offering of Alibaba, an e-commerce giant that’s been described as China’s version of Amazon, eBay and PayPal rolled into one.
But many consumer-related names have been under pressure in the current economic environment, as the slowing economy has caused weakened consumer spending and hurt some industries such as department stores and supermarkets. In addition, many consumer-oriented companies that historically sold at higher valuations versus other sectors in the economy have been given haircuts by investors.
“We think the weakness in consumer sentiment and spending is a cyclical slowdown rather than a structural problem,” Gao says.
Discount Price
The general weakness in the Chinese economy has put a damper on Chinese stocks so far this year. Returns on the Shanghai Composite Index (“A” shares trading in Shanghai and open mainly to domestic investors only) and the Hang Seng Index (“H” shares of Chinese mainland companies trading in Hong Kong and available to overseas investors) were both negative as of mid-April.
Mutual funds and exchange-traded funds, generally a safer way to invest in China, not surprisingly have also suffered this year with the overall China-focused mutual fund category tracked by Morningstar down 3.7% as of mid-April. Meanwhile, the vast majority of China-related ETFs were also in the red.
Beecroft believes the recent downturn in Chinese stocks has created compelling valuations. As of the end of the first quarter, Beecroft says the Chinese market traded at about eight times forward earnings, versus about 11 times for Asia ex-Japan and about 15 times for the U.S. “You can debate the slowdown in China and some of the risks, but you need to ask what’s in the price,” he notes. “A lot of the bad news has been discounted in China, so there’s valuation support for the market.”
It’s hard to ignore the steady drumbeat of bad news coming out of China, but it’s also hard to ignore its huge economy, which someday will likely become the world’s largest. For investors with long-term horizons and an understanding of the changing Chinese economy, this is a wall of worry that might be worth trying to climb.