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JP Morgan: With China’s Growth Ebbing, What’s Next?
Aspire, Investments | 17 April 2015
By: Lim Si Jie
Articles (169) Profile

China’s contribution to the global Gross Domestic Product (GDP) has grown from a mere five percent in 1990 to 40 percent in 2010.  As a result, growth in many Emerging Market (EM) countries have become more and more influenced by what happens in China. However, as China’s growth slows down, countries that export raw materials to China are struggling.

China’s Slowdown Signals Tough Road Ahead For EM

The China slowdown had been felt in commodity-exporting countries.  Since its peak in 2011, the price of a representative basket of commodities that China consumes has fallen by up to 40 percent. EM countries that export commodities to China have experienced falling export revenues, falling growth and underperforming equity markets.

JP Morgan expects big commodity exporters (Brazil, Chile, Colombia, Peru, Russia and South Africa) to “face another tough year in 2015” as it continues to be bearish on commodity prices.

EM Manufacturing Countries To Benefit From Lower Oil Prices

If investors are looking to invest in EMs to diversify their portfolio, JP Morgan holds the view of investing in EM manufacturing countries with “competitive labour cost growth against China, and more stable profit margins.”

These countries include Czech Republic, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Philippines, Poland, Taiwan and Thailand. These countries are expected to benefit from lower oil prices, with many being larger net oil consumers than Europe.

China GDP Growth Hangs In There

JP Morgan observes that the Chinese GDP “no longer tracks corporate profits as well as it once did.”  There is a growing divergence between China’s GDP and corporate earnings. GDP may not be able to be considered as a “China barometer.”

As China shifts away from a capital-spending driven model, Chinese GDP growth is expected to stay at around six percent. This is considering that the housing and capital spending overhangs are being worked off. Furthermore, the six percent growth takes into consideration the substantial government sponsored spending and subsidies.

However, Chinese capacity growth was financed by corporate debt and has brought down China’s overall utilization rate and the rate of corporate profits growth.

Bad News Already Priced In

In view of this, JP Morgan is quick to point out that a lot of bad news is already priced in. Chinese shares are currently trading at the lowest multiple in the EM markets (other than Russia), even after accounting for the large sector representation of large Chinese banks and energy companies.

For example, when looking at Chinese bank stocks, investors are already pricing in credit losses of 11 percent of all loans, which is equivalent to those incurred by US banks after the global financial crisis.

Local Chinese Equity Market

Companies listing in Shanghai and Shenzhen are often SMEs (Small & Medium-sized Enterprises) with higher profitability and better growth trends than SOEs (State-Owned Enterprises). There were quotas for foreign investors ownership, and allocations used to be made selectively to a few asset managers. However, quotas are now being loosened and it is easier for investors to buy into these stocks.

In terms of performance, locally listed shares have generated better performance than the MSCI China Index since 2009, albeit with more volatility.  The recent spike reflects increasing use of margin debt in China, a rate cut by the central bank, and the benefit of falling oil prices.

In other words, speculation is involved. For those looking for more stability or diversification, it is better to seek them in other markets.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.

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