2011 expansionary policy favours Chinese equities
We see scope for significant gains in Chinese equities in the year ahead, despite anaemic growth in the developed world, based on our expectation that Chinese tightening will give way to expansionary policy early next year. This should offset weak growth in the US, while we also expect a debt crisis to be averted in the euro-zone, at least for the time being.
A key catalyst that we see for triggering a move higher in Chinese equities is a shift in forecasts from continuing tightening by China’s policy-makers to expectations for a pause and eventually to an easing cycle in 2011.
As noted in a previous Daily Theme, we forecast headline CPI inflation in China to begin decelerating in late 2010. Real economic activity has slowed since China’s tightening phase began in late 2009, including a decline in the growth rate of industrial production from the 17-18% range to 13-14% currently. While this is still a rapid pace of growth, 13.7% average growth in industrial production over the past three months represents a slowing trend.
Annual growth in Chinese property prices has also slowed for four consecutive months, and consumer demand also appears to be softening. Growth in retail sales, typically the last sector to turn in the economic cycle, has slowed from 33% to 24%. We expect this trend to intensify in early 2011, and believe these developments should allow Chinese policy-makers to follow the current pause in tightening with a shift towards a more accommodative policy stance early next year.
Meanwhile, profits for companies in the MSCI China Index are expected to grow 19% in 2011. While we think these may be high, with leading economic indicators suggesting corporate earnings growth is more likely to be in the range of 13-15%, at current levels Chinese equities are still attractively valued. The MSCI China currently trades at a price-to-earnings (PE) ratio that is below its longer-term average, based on trailing 12-month earnings, while the PE for the Shanghai Composite is near historic lows.
Conclusion
Given attractive valuations, forecasts for solid earnings growth and expectations for more accommodative policy from China and the US next year, we believe Chinese equities are poised to make substantial gains over the next 12 months. And with the return to a managed-float exchange-rate policy, foreign investors also have the prospect of a strengthening yuan to boost their returns.
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