Year of the Pig set to be volatile for China investors

The Year of the Boar may be a volatile one for investors in the Chinese stock market, but the long-term growth story of the emerging powerhouse still holds good, says Fidelity International.

In January, the Chinese government implemented a series of gentle austerity measures targeted at the domestic equity markets in an attempt to slow the rising market. These measures included the suspension of new issues of mutual funds; the tightening scrutiny over SOE stock trading; and public announcements by some officials that people should be cautious about the domestic stock market.

While at first glance it may seem that the government looked to slow overall investment levels, we believe the overall aim is to improve the quality and manage the level of growth. More recently, the government has relaxed its attitude to the market, lifting the restriction on new mutual funds, by granting licenses to five more equity focused mutual funds. Previous tightening measures implemented in 2006 were targeted at more environmentally-unfriendly industries such as lower-end steel and coal mines. Conversely, other projects such as railway construction and power grid upgrades were accelerated, highlighting the emphasis towards improving quality.

2006 was a great year for Chinese markets with shares on the Hang Seng Mainland Composite Index, Shanghai Composite Index and Shenzhen Composite Index jumping 72%, 130% and 97.5% respectively, substantially outperforming the rest of the region. Concerns about the sustainability of the scale and strength of the growth, combined with the measures taken by the government, led to market falls early this year. “But,” according to Martha Wang, Manager of the Fidelity China Focus Fund, “The falls are temporary setbacks for investors. Economic growth remains strong and corporate earnings are healthy.

“For much of 2006 and into 2007, the rise in the market was relatively well supported by earnings growth as the market played catch-up following more modest performance over the previous couple of years. The market started to trade at valuation levels which were above historical averages so it is not surprising that the market has experienced these short term setbacks.

“Indeed, I believe that the recent falls should be considered a normal part of the market cycle given the scale and speed of the market’s advance over the past 12 months and I continue to remain positive about China as a long-term investment.”

There were a large number of new IPOs coming into the market last year – 157 compared to 94 in 2005- and markets benefited as investors were given more choice and diversification opportunities, particularly in sectors going through secular growth such as consumer lending, retailing and real estate. Another driver of market performance was the strong appreciation of the Renminbi. This not only benefited local companies but from a macro-economic perspective, has also kept inflation and interest rates relatively low.

“Looking forward,” concludes Ms Wang, “strong corporate earnings momentum should continue,” concludes Ms Wang. “In 2006 results largely exceeded market expectations, and for 2007 consensus forecasts are suggesting that another 13.4% growth year on year is possible. We are seeing higher valuations being supported by earnings growth, higher quality of firms listing, better corporate governance and ongoing state-owned enterprises reforms.”