Outlook for Chinese equities remain strong

Gigi Chan, manager of the Threadneedle China Opportunities Fund says, despite a slowdown in GDP growth, China is still well placed to deliver far superior levels of economic growth than almost any other economy in the world. The forecast of around 7 per cent growth in 2009 compares to expectations of significant contraction in Europe, UK and the United States.

Gigi Chan comments: "Already we have seen the outperformance of the Chinese market year to date, as domestic investors have returned to the market, confident that the impact of the Rmb 4 trillion (US$586bn) fiscal and monetary stimulus launched by the government in November last year will filter down through to the broader economy. Year to date the Shanghai Composite Index has increased by as much as 30 per cent, making it the best performing stock market globally.

"There are a number of drivers boosting the Chinese economy. Firstly, and perhaps most importantly, is that China is very strong fiscally, with a budget surplus running at 1.2 per cent of GDP. This means that the government is well placed to deliver supplementary stimulative measures if required at a later date.

"Secondly, the country boasts a healthy banking system, with robust balance sheets that have minimal exposure to sub prime assets. Unlike leading western economies, China has not had to undergo the process of corporate and private de-leveraging. As a result, there is an abundance of liquidity and we have already seen an aggressive pick up in bank lending so far this year. Another positive is that deposit growth also remains strong, with the loan to deposit ratio currently running at around 70 per cent.

"Thirdly, the financial position of the Chinese consumer is very sound. Unlike consumers in the West, Chinese consumer debt levels are very low and as such will benefit from the effects of the large fiscal stimulus package. Even if we are seeing a slowdown in consumer spending, at last count retail sales still came in at 15.2 per cent in February this year (down from over 20 per cent in 2008). As such, we believe that consumer companies, particularly those with strong brand franchises that will see market share gains, will continue to perform going forward.

Gigi Chan continues: "Strong investment opportunities have emerged from infrastructure spending as the government's stimulus package focuses on infrastructure investments. In particular, the railway system requires urgent expansion and the Ministry of Railway has announced Rmb 2 trillion (US $290bn) of ongoing investment in the railway network. Some of the main beneficiaries include fixed asset investment related companies in the construction, machinery and basic materials sectors. However, it's important to note that a focus on corporate profitability is key. For example, some construction companies may find it hard to contain costs given the logistical challenge of managing the onslaught of projects at the same time.

"More generally we expect corporate earnings to bottom out in the second half of 2009 and are forecasting a strengthening earnings recovery going into next year. Valuations look attractive, especially since we are now beginning to see earnings upgrades as the economy starts to recover from the bottom. We also believe that the current market conditions will be suited to a stock picking style. When global liquidity conditions were favourable, stocks were driven up indiscriminately. However, in more difficult market conditions investors will focus more on individual companies' financial health and their ability to survive and grow."

Gigi Chan concludes: "Overall we believe that China represents an attractive investment destination for investors who can look past the current economic and corporate uncertainties to the prospect of an earnings recovery in 2010. Positives for China include continued economic expansion - albeit at a slower rate than last year - as structural growth trends remain intact. The banking system is robust and moreover the size of the government's fiscal surplus means that it is well placed to deliver additional stimulative measures if required."