Insight archive for Clive McDonnell | Standard Chartered

Why Asia’s tech industry is a magnet for investors

Clive McDonnell — Tue, 22 May 2018 14:01:46 +0000

Home to two of the world’s biggest technology companies – Samsung and Tencent – Asia’s tech sector is increasingly becoming a global force to be reckoned with, offering good value for investors and consumers alike.

‘Winner takes all’ is the new mantra for Asia’s cash-rich tech companies, which span the technology spectrum from cloud computing to internet shopping, as they spend to increase their market share. The growing trend for mergers and acquisitions in the sector helped Asia tech stocks rise by an impressive 60 per cent in 2017.

Meanwhile, sovereign wealth funds are eager for a piece of the pie. They’ve been pouring money into Asia’s technology ‘unicorns’ – private companies valued at USD1 billion or more – in a bid to get maximum exposure to the most promising tech companies, and their eggs are not confined to one basket.

"Despite the huge wave of investment, Asia's technology industry is still in its infancy"

Clive McDonnell Head of Equity Investment Strategy

In some cases, private funds are backing two or more companies that provide the same services in the same country, in a bid to ensure they end up the winner, whichever investment comes out on top. Moves like this demonstrate just how big investors think the prize is.

And as the battle to back the right companies continues, consumers in some of Asia’s fastest-growing economies are proving to be the biggest winners of all as they leapfrog their way into the future. Across India, Indonesia, the Philippines and China, affordable smartphones act as the gateway to the internet for those who could not dream of owning a personal computer, while the traditional aspiration to own a car is being replaced with the convenience of on-demand transport apps.

A growing, but infant, industry

Yet despite the huge wave of investment, we believe Asia’s technology industry is still in its infancy, especially given the significant demand for infrastructure across the region. Developing Asia needs to invest USD26 trillion by 2030 to resolve its infrastructure gap , according to the Asian Development Bank.

Across the region, hundreds of billions of dollars need to be spent to expand telecommunication and broadband networks, water supply, power and transport systems. These investments are expected to push technology to the limits, given the increased focus on energy efficiency and promoting a cleaner environment. Think about all buses in China switching from oil to electric transmission, not to mention the introduction of self-driving cars, in the not-too-distant future; or solar power accounting for a greater share of India’s electricity grid; or hi-tech desalination plants helping Asia tackle a growing water deficit.

These possibilities will likely present investors with unprecedented opportunities to make long-term returns. If you add to this the fact that tech unicorns in Asia, which are not currently accessible to ordinary investors, could start to list their shares on regional exchanges in the coming months, the tech industry will likely continue to boom.

This is not research material and it has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. This commentary is provided for general information purposes only, it does not take into account the specific investment objectives or financial situation of any particular person or class of persons and it has not been prepared as investment advice for any such person(s). Further details can be found in these terms & conditions.

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Say goodbye to the ‘Goldilocks’ investment landscape

Clive McDonnell — Mon, 23 Apr 2018 11:41:34 +0000

We are entering a new era of market volatility.

Equity and bond investors need to be prepared as the not-too-hot-not-too-cold ‘Goldilocks’ landscape of 2017 gives way to a more turbulent reflationary scenario – characterised by slightly faster growth and inflation – in 2018.

That Goldilocks scenario came about thanks to a combination of steady growth, low inflation and falling market volatility, which helped drive investor returns. The effect on global asset markets was extremely positive. But change is now afoot, and we believe investors should be prepared for greater uncertainty as the global economic cycle matures.

"The sweet spot in global equity and bond markets is behind us, and generating returns from the market will become trickier"

Clive McDonnell Head of Equity Investment Strategy

Equity market volatility, as measured by the S&P500 VIX index, is likely to trade in a volatile range of 15-20 in 2018, far higher than the low of 9.1 back in November last year.

Meanwhile, inflation, as measured by the US core consumer price index, has also passed the low for this cycle. It’s currently 2.1 per cent, up from 1.7 per cent in August 2017. As inflation rises, so do bond yields, although we believe that structural factors, including demographics and job insecurity, are likely to limit the upside on both.

The combination of moderately higher bond yields and increased volatility has significant implications for investors as it implies that the sweet spot in global equity and bond markets is behind us, and generating returns from the market will become trickier.

Why we prefer equities

Despite the market uncertainty, equities are still our preferred asset class, and we believe investors should have an above-benchmark allocation. Asia ex-Japan is our preferred market, reflecting a combination of factors, including strong earnings growth expectations for 2018 and attractive valuations at 13 times the 2018 consensus earnings forecast.

Within Asia ex-Japan, China is our preferred market because strong earnings growth and financial de-leveraging is reducing risks in the financial sector. In addition, investor flows are rising from Shanghai to Hong Kong, as mainland China investors warm up to Hong Kong-listed equities, especially in the technology and financial sectors. The flows through the Hong Kong-Shanghai Stock Connect system now account for 15 per cent of turnover in the Hong Kong stock market (Hang Seng Index), up from 10 per cent last year.

"While we are likely headed for more turbulent times, we do not believe that investors should feel nervous"

Clive McDonnell Head of Equity Investment Strategy

Asia will benefit from a weaker US dollar

We expect the US dollar to weaken further, albeit moderately; a shift that is likely to be positive for Asia ex-Japan and other emerging markets. This is because, as the US dollar weakens and Asian currencies strengthen, regional central banks release local currency to buy US dollars in order to hold down the value of their local currencies. While some of the increase in local currency supply can be absorbed via issuing bonds, it generally has the effect of increasing domestic liquidity and holding interest rates lower than would otherwise be the case. We expect higher liquidity and lower interest rates to drive equities and other local asset prices higher.

Bonds are still core

Fixed-income investors also need to adapt to the new era of higher inflation and volatility, as it is likely to undermine returns from developed market government bonds. We continue to view bonds as core to investors’ holdings, preferring emerging market US dollar and local currency bonds. These bonds include a wide-yield premium over US treasuries that offer a cushion in a rising yield environment. The recovery in commodity prices is also an important driver of emerging market (EM) US dollar bonds, while a weaker US dollar is positive for EM local currency bonds.

The ‘just right’ investment scenario looks like it’s behind us. But while we are likely headed for more turbulent times, we do not believe that investors should feel nervous, as the kind of valuations we’re seeing suggest global equities and emerging market bonds still have the potential to deliver positive returns.

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Seizing China’s ‘new economy’ opportunity

Clive McDonnell — Tue, 23 Jan 2018 16:49:46 +0000

For international investors looking for the next big opportunity, China’s ‘new economy’ companies offer plenty.

In contrast to economies in Japan, Europe and to a lesser extent the US, new growth drivers in China have emerged in the technology, transportation and consumer services sectors. The marginal return on investment in these sectors is increasing and they do not have the same dependence on debt as companies in China’s old economy – such as manufacturing – sectors.

Big data is a big deal

If ‘big data’ generates competitive advantage for businesses in the first half of this century, China’s leading technology companies have a unique advantage. China’s vast population of 1.4 billion people are avid smartphone and social media users, giving these companies a huge stream of data to analyse – and use – to grow their business.

"China’s government understands the importance of creating new growth drivers"

This data will inevitably help China’s technology companies tailor-make new solutions for their customers, especially in the sharing economy. This is evident from the emergence of major app-based companies dedicated to cab-sharing, bike-sharing and online retailing over the past five years.

China’s government understands the importance of creating new growth drivers to take over from the old economy behemoths. It has approved foreign investment by China’s technology sector leaders, even as authorities clamped down against foreign investment by old-economy conglomerates, enabling them to access the latest know-how from abroad and help China rise up the technology ladder.

Belt and Road is the next big growth driver

China’s huge population provides the ‘new economy’ sector an attractive market to experiment new ideas and technology. However, the economy is also relatively protected, which some investors worry could result in the companies resting on their laurels.

Policymakers are very much aware of this.

China’s Belt and Road (B&R) initiative – which involves large-scale infrastructure development along China’s centuries-old trade routes across Asia, Africa, the Middle East and Europe – is part of the solution to ensure Chinese companies continue growing. B&R offers new opportunities and a road map to tap into millennial consumers across a much wider market. Chinese companies are taking advantage of this opportunity by gradually grabbing market share in the instant messaging, e-commerce and sharing economy across South and South-East Asia.

"There are a range of Chinese companies listed in the US, UK, Singapore and Hong Kong"

There is an opportunity for global investors here. During the 1990s growth spurt, international investors did not have easy access to rapidly growing companies in China’s finance, materials and energy sectors, as many were unlisted. Today, there are a broad range of Chinese companies in fast-growing technology, transportation and consumer services sectors which are listed in the US, UK, Singapore and Hong Kong. This has made them easily accessible to global investors, and those looking for some of the most exciting growth opportunities worldwide today should look no further than their nearest stock exchange.

Asia’s market rally set to continue

Clive McDonnell — Thu, 10 Aug 2017 08:00:35 +0000

Asia’s equity markets have had their best start to the year since 2009, rising almost 30 per cent so far this year, and the rally is likely to continue for the rest of the year.

Driven by US dollar weakness, a solid earnings recovery and a diminishing chance of punitive US import tariffs, China and South Korea – our preferred Asian markets – have led the pack, posting gains of 36 per cent and 31 per cent respectively.

Consensus forecasts suggest earnings growth in Asia ex-Japan is likely to increase by 18 per cent this year, following a 1 per cent decline in 2016, with China leading the recovery. Meanwhile, South Korean equities, for which exports are an important growth driver, have been favoured by investors amid easing of political risks and reduced likelihood of US import tariffs rising.

A weaker dollar, besides allowing Asian central banks full control of their monetary policy, is generally supportive for Asia as it results in an increase in capital inflows, boosting demand for its stocks and bonds.

Room to run

Looking ahead, the factors behind the Asian equity rally – US dollar weakening, positive earnings expectations and low likelihood of a US import tariff – are likely to remain in place for the rest of the year, but there are new catalysts that could help sustain it too, such as policy paralysis in Washington, which is good news for Asian and global asset markets as it reduces the risk of additional US stimulus at time when there is little spare capacity in the US economy.

So Asia’s equity market has further room to run, but will China and South Korea continue to lead the pack? We think so.

"There are clear catalysts that may enable Asia ex-Japan markets, and China and South Korea in particular, to post solid returns in the second half of this year"

Clive McDonnell Head of Equity Investment Strategy

The recent decision by MSCI, a provider of index data, to include China’s locally listed ‘A shares’ in its global list of equity market indices is significant. Although the short-term impact is likely to be modest, given the weight of the included shares in the MSCI Emerging Markets Index is a mere 0.7 per cent, looking ahead to 2025, the weight of the A shares could increase to 12 per cent.

Another driver of Chinese equities is China’s increased focus on maintaining financial stability. Plus, we believe the Chinese government is keen to support a positive wealth effect from rising real estate prices ahead of the government’s congress meeting in autumn.

‘Trapped liquidity’ is the other likely driver of China’s equity markets for the rest of the year. Chinese companies have been on an acquisition spree until recently, having spent USD246 billion in overseas acquisitions alone in 2016. This is reminiscent of the acquisitions by Japanese companies prior to the Japan’s bubble bursting in the late eighties.

Keen not to repeat the same mistakes, policymakers have withheld approvals for overseas acquisitions this year, pressuring banks to reduce credit for such transactions, resulting in acquisitions plummeting by 67 per cent in the first four months of this year. We think the tightening is positive as it traps liquidity within the domestic economy. It will also help reduce corporate debt in China from growing any further, given that most of these acquisitions are debt-financed.

Easing tensions in South Korea

When it comes to South Korea, in our view, there are a number of positive developments that will support equities in the second half of this year – the most significant being the decline in political risk following the change in government which has led to an easing of tensions with China. Other factors include reforms aimed at improving shareholder returns and accelerating corporate restructuring.

We believe there are clear catalysts that may enable Asia ex-Japan markets, and China and South Korea in particular, to post solid returns in the second half of this year. In fact, we think returns could be strong enough to outperform global equity markets for the first time since 2012.

China equities: the bull market is back

Clive McDonnell — Thu, 06 Apr 2017 10:49:51 +0000

China’s equity markets have been on a wild ride in recent years. After peaking in 2015 to its highest level since 2007, the Hang Seng China Enterprises index plunged almost 50 per cent by February 2016. Since then, the bull market has returned, with the index rallying 37 per cent – and we believe this bull market can continue, for five reasons.

1) A more stable economy

China’s economy has stabilised after a number of years of fiscal, monetary and credit easing. Although growth has been on a secular downtrend since 2010, the government has a growth target for 2017 of ‘around’ 6.5 per cent. The stabilisation in economic activity – which is confirmed by the so-called ‘Li Keqiang’ index which tracks underlying economic indicators such as bank lending, rail freight movement and electricity consumption – has helped calm nerves, slowing down capital outflows in recent months. A resilient economy, combined with a broadly range-bound US dollar and official measures to restrict fund outflows, has helped stabilise the yuan.

2) Increased domestic liquidity

Beijing’s efforts to tighten capital controls have resulted in increased domestic liquidity. As capital can no longer flow as freely overseas, it is finding its way into domestic asset markets, including equity and real estate. Although administrative controls have tried to control the pace of property price appreciation, Shenzhen and Shanghai have witnessed more than 50 per cent and 20 per cent price gains respectively over the past 12 months. Moreover, the so-called ‘sell-through rate’ – percentage of housing units sold at project launch – has risen in recent months as buyers return to the market.

""New economy’ sector earnings are expected to grow 21 per cent this year, compared with 7 per cent growth in ‘old economy’ sectors such as energy, industrials and materials""

Clive McDonnell Head of Equity Investment Strategy

3) Rising corporate earnings expectations

The improvement in underlying economic activity is showing through in rising corporate earnings expectations. Consensus forecasts estimate a 16 per cent earnings growth for the MSCI China index for 2017, up from a contraction of 8 per cent in 2016.

While the main drivers of the earnings recovery centre on the telecom and consumer staples sectors, ‘new economy’ sectors such as technology, consumer discretionary and healthcare are the clear favourites. This is backed by strong earnings estimates – ‘new economy’ sector earnings are expected to grow 21 per cent this year, compared with 7 per cent growth in ‘old economy’ sectors such as energy, industrials and materials. Moreover, the technology sector dominates China’s equity markets, accounting for a 32 per cent share of the MSCI China index, making it a key driver of the overall market.

4) Inexpensive equity market

China’s equity market remains inexpensive relative to peers. The market is valued in line with its long-term average, but is cheaper than major market indices such as the S&P500 index.

5) Benefits of a stabilising US dollar

A stabilising US dollar should help attract foreign fund flows back to Asia, which is likely to benefit China, the largest market in the region. China’s policymakers are likely to prevent any significant yuan depreciation as they tighten controls to limit capital outflows. This may contribute to continued excess liquidity in the domestic economy, buoying asset markets including equities.

""China’s equity bull market has longer to run""

Clive McDonnell Head of Equity Investment Strategy

Investors in China’s equity markets have had a rocky ride in recent years. Some risks have not gone away, including elevated debt levels at companies and the possibility of a stronger US dollar and weaker yuan as the US Federal Reserve accelerates the pace of rate hikes. Another risk is President Trump enacting punitive trade policies against major exporters such as China. Any of these factors could raise the risk of a sharp deterioration in China’s economic growth.

However, we see a low probability of such an outcome. For now, the combination of China’s policy-led stabilisation in economic growth, strong earnings growth driven by consumption-led new economy sectors, attractive valuations and ‘trapped liquidity’ as a result of tighter capital controls give us confidence that the equity bull market has longer to run.

Time for equity investors to accept lower returns?

Clive McDonnell — Thu, 01 Dec 2016 14:19:45 +0000

Investors are understandably cautious these days. With global equity markets volatile throughout 2016, the investment environment remains uncertain.

Although equity markets could post positive returns before the year is out, we believe this will be accompanied by greater and more frequent market fluctuations.

The uncertainty makes certain investment strategies such as multi-asset income investments attractive as they are less sensitive to fluctuations. Such strategies may come with modest returns, but for income-orientated investors we think this is a trade-off worth making in the current environment.

"India and Indonesia are our two most preferred markets in Asia"

Generally, we are cautiously positive on Asia excluding Japan, but our view could change if the US dollar’s strength continues. While India and Indonesia are our two most preferred markets in Asia, we are becoming more positive toward China, as recent developments have the potential to reduce equity market risk in the region. For instance, China’s banks, which have been a perennial concern for investors, have started to address their non-performing loan problems in recent quarters.

Meanwhile, the Shenzhen-Hong Kong Stock Connect will give international investors access to compelling investments such as mainland-listed high-growth technology companies for the first time.

In China, we currently favour new economy stocks, including those in the internet and services industry groups. The former is benefiting from the growth in the e-commerce and the latter group gives investors direct exposure to the rising middle class and urbanisation trend.

Trump victory aftermath

We believe the US economy is in a late business-cycle environment, which tends to feature declining margins. While margins have been under pressure for some time, they are positively correlated with inflation. As inflation expectations have recently started to increase, this could provide an unexpected late cycle boost to corporate margins in the US.

US corporate earnings are forecast to recover in 2017, driven by an improvement in the energy sector, but if President elect Trump follows through on his pre-election promise of cutting corporate taxes and boosting infrastructure investment, this could boost corporate earnings too.

Opportunities from a weaker pound

In the UK, we are positive on stocks that are benefiting from the weakening British pound, particularly those with significant amount of earnings derived outside the UK, including blue-chip names with stable assets and solid dividend yields. Meanwhile, while pound remains weak, it is undervalued, and current levels could represent a good opportunity for long-term investors.

On the radar

Looking ahead, upcoming risks to keep an eye on include the pace of interest rate increases by the US Federal Reserve (Fed), and elections in Europe which could lead to the rise of populist parties. While the market is anticipating higher interest rates, spikes in volatility around the the Fed’s decision cannot be ruled out.

One of our preferred equity themes, especially in the US, is domestic consumption. It is more defensive relative to its peer – global consumption – which tends to be more cyclical. This preference complements our stance towards global equities and represents an opportunity for investors to benefit from an investment theme which could last for years.

More broadly, multi-asset income strategies offer income-orientated investors modest returns with lower risk in the uncertain environment. However, investors willing to take on more risk for higher potential returns could consider equities in the US and Asia ex-Japan, especially India and Indonesia, and the ‘domestic consumption’ theme.

Investing: getting ahead of the uncertainty

Clive McDonnell — Thu, 15 Sep 2016 10:53:16 +0000

The outlook for equity markets for the rest of this year has become more challenging. For starters, investors will need to weigh up the implications of Brexit, recent banking stress tests, and the increased uncertainty over the timing and pace of Federal Reserve (Fed) rate hikes.

The common thread linking all these factors is uncertainty – which is to asset markets what a pin is to a balloon.

The UK’s decision to leave the European Union (EU) poses as many challenges for the euro area economy as it does for the UK. For this reason, we have downgraded our outlook for euro area equities to ‘cautious’ from ‘positive’ – and upgraded UK equities to ‘cautiously positive’ from ‘cautious’, reflecting the benefit of a weaker pound on internationally focused large UK corporates.

"The euro area’s challenges pre-date Brexit"

Banks have been at the forefront of the uncertainty created by the Brexit vote, compounded by the results of the European Banking Authority stress test. European-listed banks have under-performed those listed in the UK year to date, reflecting fears over the possibility of new capital raising and lower dividends in the coming quarters.

Lower policy rates are also a concern for UK banks following the Bank of England’s decision to cut rates and re-start quantitative easing.

The euro area’s challenges pre-date the Brexit vote. Lacklustre revenue growth and an appreciating euro were already weighing on the export sector, with consensus earnings growth for the euro area equity markets in 2016 forecast at a mere 1 per cent.

While consensus estimates still project a 12 per cent rise in euro area earnings in 2017, it is almost inevitable that they will come under downward pressure in light of recent events.

More confident in US earnings growth

The S&P500 has a similar pattern for consensus earnings: flat this year, rising to 14 per cent in 2017. However, we have greater confidence in the achievability of US earnings growth, as companies there are somewhat insulated from developments in the EU, and could actually be beneficiaries of increased domestic investment diverted from the EU.

Another factor supporting US earnings growth in 2017 is the recovery in energy sector profits – not just from higher oil prices, but also the dramatic decline in asset write-downs related to the prior collapse in oil prices.

Corporate investment tends to thrive in an environment of growth and certainty, both of which are in short supply in Europe currently. Companies in the transportation and communications sector have already announced reviews of future investment in light of Brexit. Such news will be received negatively by investors and policy makers alike.

Slower investment will impact future profit growth and could also weigh on economic growth in the coming quarters. Already this has prompted the Bank of England to cut rates and re-start quantitative easing. It could also lead the Fed to think twice before raising rates.

While lower-for-longer US rates would have positive implications for high dividend yielding equities and fixed income markets, it reinforces our concern over the outlook for earnings growth and is a factor in our decision to reduce our allocation to equities since the start of this year.

Given all of this, what options do investors have?

"Multi-income strategies rank highest in order of preference amongst the key asset classes"

We continue to emphasise the importance of multi-income strategies, which rank highest in order of preference amongst the key asset classes. We also believe that alternative strategies and fixed income, specifically developed market corporate bonds and emerging market US dollar government bonds, should feature prominently in investor allocations. Meanwhile, equities, commodities and cash rank in the lower half of our asset class preferences.

While we have reduced our allocation to equities as an asset class, high dividend-yielding equities are attracting renewed interest in light of the fluctuating expectations for rate hikes by the Fed. There is also renewed interest in emerging markets, buoyed by the recovery in commodity prices from prior lows and selectively high dividend yields. Indeed, within equities, we have the highest preference for Asia ex-Japan stocks, which rank slightly above US equities.

Asia recovery offers compelling opportunities

Earnings revisions have started to recover in Asia as analysts have become more positive on the outlook for domestic demand following the easing of monetary policies across many markets in the region. With valuations now more attractive than earlier compared to developed markets and non-Asia emerging markets, we expect a recovery in portfolio flows leading to performance in Asia ex-Japan playing catch up with that in non-Asia emerging markets.

Uncertainty looks set to remain a feature of asset markets for the rest of the year. Nevertheless, there remain opportunities for those who adapt their investment strategies. In particular, investors will need to keep a close eye on several upcoming political events, including the Brexit talks, the Italian referendum in October and the US Presidential election in November.

Equity investing: staying ahead of the game

Clive McDonnell — Wed, 09 Mar 2016 14:02:11 +0000

Astrong US dollar, falling commodity prices and lacklustre earnings growth were all factors that weighed on markets in 2015 and the same is expected in 2016.

However, we believe investors need to be ready to reposition their investments in case there’s a change in direction of one or more of these factors. Higher commodity prices and earnings growth would be positive for emerging markets, as would a weaker dollar.

"Within Asia, we are positive on China, negative on Malaysia"

We are positive on Japan and Europe. We are cautious on the US and Asia ex-Japan and negative on Emerging Markets outside Asia. Within Asia, we are positive on China, negative on Malaysia.

China’s market

The Chinese equity market has witnessed a challenging start to the year. Nevertheless, we remain positive, focusing on the new economy sectors including services and the consumer. We are negative on old economy sectors including manufacturing and heavy industry.

In the past, it was challenging for investors to buy into the ‘new China economy’ view as equity indices tracked by funds were dominated by old-economy sectors. However, recent changes to the MSCI index methodology have substantially increased the weight of new economy sectors at the expense of the old economy.

Three key themes

Given the volatile start to equity markets in 2016, the likelihood of sticking with a plan outlined today for the full year is slim.

However, knowing the key themes in the market and understanding the risks and opportunities associated with these should help investors protect and grow their investments.

We think the three themes for the year ahead are:

The positive effect of modest increases in US interest rates on US banks
The structural shift towards cloud services and the positive effect this is having on US-listed technology firms
Continued growth in Mergers & Acquisitions (M&A) activity

Rising rates – positive for US banks

Rising rates having a positive impact on banks can appear counter-intuitive as investors often view higher rates as signalling increased loan defaults and falling demand for credit. While undoubtedly a side effect of higher rates, this usually happens later in the cycle as opposed to early stages of rate increases.

In the early stages, banks are able to widen the spread between what they charge borrowers for loans and what they pay depositors in interest. This wider spread can lead to higher profits.

Growth in cloud services

The growth in cloud services as a driver of earnings in the technology sector emerged as a big theme in 2015 and we expect this to continue. Analysis by Bloomberg highlights only 25 per cent of the USD228 billion available market for cloud services in the US has been tapped so far by technology companies, implying significant future growth for this new industry.

More M&A activity

Global M&A activity reached USD5.7 trillion in 2015, surpassing the prior cycle peak of USD4.9 trillion in 2007. As each cycle brings a new high in M&A, we believe potential for a further increase in 2016 remains. We expect the technology sector to be a prime beneficiary of this trend as US companies put some of their cash held overseas to work.

The risks to watch

We believe watching market risks will be important for preserving and growing the value of investments in 2016. The key risks to keep an eye on include:

Policy mistakes in the US, China and Europe. This covers an unexpectedly rapid increase in rates by the Federal Reserve, a miscalculation by authorities in China over the appropriate pace of currency weakness, and the migrant crisis in Europe leading to an unexpected political response
Oil prices are currently low, whereas geo-political tensions in the Middle East have never been higher. Historically, political tensions resulted in a ‘conflict premium’ in oil prices. The market is not factoring this in for now, but could do so in the future
Earnings disappoint remains a key risk. The S&P500 recorded no growth in earnings in 2015; this year’s consensus expectations are for a 4 per cent increase. The key risk for markets is a failure to achieve on this recovery

So it’s not been the smoothest start to the year for investors, which means being prepared to re-plan investments is just as important as having the right strategy.

This document is not research material and it has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. This commentary is provided for general information purposes only, it does not take into account the specific investment objectives or financial situation of any particular person or class of persons and it has not been prepared as investment advice for any such person(s). Further details can be found in these Terms & Conditions.

Chinese stocks – where to look

Clive McDonnell — Fri, 12 Jun 2015 11:33:06 +0000

China is refocusing its economy towards consumption and services, away from investment and manufacturing.

While this pivot is happening slowly from an economic perspective, investors in the Chinese stock market have been quick to switch their exposure accordingly.

Chinese stock valuations have risen sharply and become increasingly stretched, but we see three key themes emerging – business sectors that still offer good opportunities for long-term investment.

Electric vehicles

These are seen as one answer to China’s pollution problem. The government aims to have 5 million electric vehicles on the road by 2020. To reach this target, it will need to build 100,000 new charging stations and bring down the high costs of electric vehicle engines, or ‘powertrains’.

Clearly, it will need the private sector help to do this, which represents a potentially attractive investment opportunity.

On-line education

Chinese parents have embraced on-line tutors as a means of dealing with the fiercely competitive university entrance exams, faced by Chinese students. The same is happening in Hong Kong, Taiwan and Singapore, where parents are also willing to spend considerable sums on tutors to give their children an edge.

Compared to traditional methods of teaching, on-line education has the potential for significantly higher margins as star tutors can teach significant numbers of students at one time, high rental costs for premises are avoided, and advertising happens via social media and peer reviews.

China currently spends 4 per cent of its GDP on education, compared to the OECD average of 6.2 per cent. But the percentage is likely to increase as urbanisation continues and the Chinese economy shifts further away from manufacturing towards services.

Online to offline commerce (O2O)

O2O is an important emerging trend within China. It gives consumers the convenience of browsing in a bricks-and-mortar store, placing the order online, and then collecting the goods from the store, as opposed to waiting for delivery. Forecasts that O2O mark the end of the shopping mall are greatly exaggerated.

Many investors cite the doubling of China’s ChiNext and CSI 300 stock indices over the past twelve months as a reason for avoiding the Chinese equity market altogether.

While we agree that markets such as Shenzhen’s ChiNext have bubble-like characteristics, overseas-listed Chinese stocks such as H-shares listed in Hong Kong, are still trading on reasonable valuations.

The three themes we have identified – electric vehicles, on-line education and O2O – are multi-year trends, which are independent of short term fluctuations in economic growth and expected to deliver above average returns.

A version of this article was first published in The Business Times (Wealth Supplement) on 02 June 2015

Important disclosures can be found in these Terms & Conditions