China’s Growth

While the election result has blown some domestic headwinds away, the U.S.-China trade war continues to generate uncertainty. It forms part of a shaky macro-economic backdrop, which is a concern given that a number of stocks we own derive a chunk of their earnings offshore.

Australia’s vulnerabilities stem largely from its reliance on China as a trading partner and on commodity prices. China’s GDP growth continues to slow and U.S. trade tariffs have added to the pressure on Chinese company earnings.

However, Beijing is striving to mitigate the slowdown by boosting consumption. It has cut taxes, introduced measures to spur demand for cars and electronics and increased infrastructure spending. All this is designed to stimulate its economy and preserve growth.

In the face of trade tensions China has also accelerated steel production. This—together with the tragic collapse of Vale’s tailings dam this year and supply disruptions—has driven up iron ore prices. This has enabled Australian miners to generate strong free cash flows, reinforcing balance sheets and enabling them to put capital spending plans in place years in advance.

We could see more earnings upgrades given prolonged elevated prices. We expect further capital management from the miners—which can drive growth in earnings per share. We favor diversified miners with strong balance sheets and cash flows and improving return profiles.

Ultimately we expect China and the United States to reach a compromise on trade given how much is at stake. In the meantime, U.S. aggression will likely speed progress in Chinese self-sufficiency—which could be a fundamental driver for domestic hardware and semiconductor firms.

Over the long term we retain confidence in China’s consumption-led growth. As incomes rise, we expect its growing middle class to pursue a better quality of life—premium products, more frequent travel and additional insurance and health-care services. We will look to invest in companies well placed to benefit from this structural trend.

Finding Value

Buoyed by the coalition’s election win, the ASX200 Index has rallied to the point of touching historic highs. It is trading in line with the S&P500 Index, with a 12-month forward price-earnings ratio of 15.5x.