Is the scene set for a re-rating of Chinese equities?

Andrew Swan, BlackRock’s Head of Asian Equities

Is the scene set for a multi-year rally in Asian markets and a re-rating of Chinese equities? 

The more detailed reform announcements released post China’s Third Plenary session could certainly see Chinese equities re-rate over the next few years as the focus of the economy moves towards a more market based approach, with private capital playing an increasingly important role in future growth. Over the long term, this comprehensive reform package might be viewed as one of the more significant economic policy initiatives undertaken since China embarked upon structural reform towards a more market based economy, initially undertaken by Deng Xiaoping.

However, implementation of reform will be key and it will take some time before we can judge how successful the reform process has been. The implication is that short term volatility is likely to persist as global investors initially look to increase their exposure to China from what has generally been an underweight allocation to an out of favour market. Chinese equity valuations remain relatively cheap but have already bounced back from their recent mid-summer lows.

Counterintuitively, the reform announcements might lead to a further deceleration in trend growth within the economy with emphasis on the quality, rather than the quantity, of growth going forwards. The previous significant role the Local Governments played in meeting economic growth targets, largely through infrastructure and property related investments, will decline as the focus moves away from investment to consumption led growth.

Picking the stock specific winners of a “New” China is now more important than ever. We have potentially yet to see some of the new companies which will be the future leaders in a more market orientated economy. Whilst the outlook for the larger State Owned Enterprises (SOE’s) is certainly bleaker as their role within the economy is diminished over time, it is by no means dim.  Given attractive valuations, these stocks could offer investors favourable returns in the near term.

From a longer term perspective, the reforms are clearly positive and have the potential to see a significant re-rating of valuations. If we also look at them in the context of improving global growth upturn, with the US and European economies improving, structural reform and further QE in Japan, combined with their relatively attractive valuations, Asian equities could be at the start of a meaningful rally.