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China’s recovery offers a good bet for investors

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From the lows of March 2020, global equity markets have recovered sharply. In line with its early economic bounceback relative to other countries, China has, unsurprisingly, managed to outperform the rest quite convincingly. The Chinese economy has shown strong signs of recovery among other emerging markets (EMs) as attributed by its gross domestic product (GDP) growth of 18.3% for the first quarter of the year.

Despite a correction in the previous month due to reports of regulatory scrutiny in tech companies and probable tightening of financial conditions, we believe China is poised for a steady recovery, with strong fundamentals for long-term investors.

China’s key economic indicators such as purchasing managers’ index, index of industrial production, retail spending and fixed asset investments have shown remarkable improvement year-on-year. Unlike most other nations, China’s covid crisis is under control. While the rest of the world contracted due to the covid outbreak, China registered a positive GDP of 6.5% in Q4FY21. We expect China’s real GDP growth for 2021 to be close to 8.5%.

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Chinese companies, represented by the MSCI China Index, derive approximately 87% of their revenue domestically. This number is significantly higher than that of other major emerging and developed markets, which provides a fillip to economic growth prospects.

Production of export goods has been on track owing to healthy capacity utilization rates across sectors. At a time when the global economy is getting stronger, China stands a good chance to shift gears in favour of exports linked to cyclical sectors.

Beijing’s thrust towards a dual circulation policy will propel the domestic market. China is transitioning from a manufacturing-cum-export model to a consumer model. This augurs well for sectors such as discretionary consumption and technology.

In financials, earnings comeback in 2021 will be on the back of easing provisions and double-digit loan growth. Fast and online retailing, consumer durables, media, entertainment, telecom, communication services, digital payments infrastructure, medical/healthcare innovation and emerging technologies are becoming increasingly relevant in China’s headline indices.

Simultaneously, the role of traditional sectors such as industrials, utilities, infrastructure and commodities in driving index performance may start reducing gradually.

Since valuations of secular growth sectors tend to be higher and investors are willing to pay a premium as well, steep market multiples can be fairly sustainable in the long run.

In recent times, news pertaining to the government’s squabbles with tech giants has been surfacing. This may continue to impact their valuations in the short term. However, the importance of technology in strengthening the Chinese economy and markets cannot be overlooked by the regulators in the long run.

Given the vagaries of international markets in general, we suggest investing in them through mutual funds. This gives investors the benefit of professional fund management and risk diversification. Investors can invest in China through the Greater China-focused (China, Hong Kong, Taiwan) Axis Greater China Equity Fund-of-Fund. The mother fund of this feeder funds has been outperforming its benchmark over the long term.

Investors who don’t wish to take concentrated exposure to China can consider a fund like Edelweiss Emerging Markets Opportunities Equity Offshore Fund. It currently invests 50-60% of its assets under management in Greater China equities, along with other EMs such as South Korea, Russia, Brazil and Mexico.

Rachana Makhija is Senior Research Analyst, iFast Financial India Pvt. Ltd.

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