Domestic consumption is driver of China's positive outlook

China's economic strength will continue well beyond the Olympic Games, according to Christian Deseglise, Global Head of Emerging Markets at HSBC Global Asset Management.

However, Deseglise warns that investors should not be seduced by the Olympics as a stand alone source of strength for the market. The impact of the Beijing Olympics on the stock market is not significant. For example, China's total investment in Olympic-related projects is estimated to have been around US$40 billion between 2002 and 2008. This pales in comparison to China's US$6.3 trillion fixed asset investment over these years.

The more important story for the stock market, Deseglise says, is China's strong domestic consumption and investment, which will continue to drive the stock market forward.

Although the Chinese equity market has suffered a volatile few months, Deseglise says there are many reasons to be confident of the long-term outlook, particularly following a correction earlier this year which has returned valuations to more realistic levels. The 12-month forward Price Earnings Ratio (PER) on the MSCI China index is currently 12-times. This compares to 22.6 times at its peak in October 2007.

Among reasons to be positive on China is the strength of recent economic data. GDP growth is 10.1%, inflation is easing and China seems to be weathering a US slowdown.

Although inflation remains China's key challenge during 2008, the overall Consumer Price Index (CPI) has slowed to 7.1% year-on-year in June from the almost 12-year high of 8.5% in April, due to easing food prices. Food inflation came down to 17.3% in June, from 22.1% in April.

Food prices, which make up about one third of the CPI, have been the key drivers of rising inflation in 2008. Since vegetable and pork supplies have been recovering from last year's levels, it is expected that food prices, and hence overall consumer prices, would gradually come down over the second half of 2008. This follows significant steps by the government to offset inflationary pressures, including implementing food price controls, measures to increase food supply and allowing the renminbi to appreciate.

Meanwhile, the Chinese economy has been holding up well against the backdrop of slowing global growth. China's exports rose 17.2% year-on-year in June, easing concerns that a strong renminbi and a US slowdown might hamper the country's growth prospects.

Deseglise adds that the People's Bank of China is unlikely to further increase interest rates. Furthermore, given China's robust fiscal situation, growth could easily be encouraged through fiscal stimulus if necessary.

Deseglise adds: "Certainly, the slowdown in US demand has been more than offset by strong demand from emerging markets. For instance, while China's exports to the US rose by only 8.6% in the first six months from a year earlier, exports to India surged 52.4% during the same period. The stronger demand from emerging markets thus helps to reduce China's dependence on the US market."

Meanwhile, an important development is the lifting of price controls within China. The National Development and Reform Commission announced in June plans to raise gasoline and diesel wholesale price, which is considered a good market-oriented policy adjustment.

Within the US$3.6 billion HSBC GIF China Equity fund, managed by Richard Wong of Halbis, the active management specialist within HSBC Global Asset Management, favoured sectors include the consumer/retail, infrastructure and banking sectors.
The positive view on the consumer and retail sectors is founded on expectations of strong retail sales growth, driven by the growing middle class and rising incomes.

Meanwhile, infrastructure is based on strong fixed asset investments, expected to continue in 2009 on the back of China's strong economic growth.

Consumption and investment served as in increasingly important growth drivers of China, thank to rising disposable incomes, China's retail sales rose 21.6% in May, close to the fastest pace in nine years. At the same time, fixed asset investment also grew 25.6% in the five months through May.

The HSBC GIF Chinese Equity fund is limiting its exposure to export-related manufacturing companies.