Earnings surprises should support further gains in Chinese equities

Positive earnings surprises should support further gains in Chinese equities, according to Philip Ehrmann, manager of the £200m Jupiter China Fund.

Ehrmann, who has recently returned from a series of company meetings in China, says that China has weathered the global financial and economic storm of the past year better than its Western counterparts. This backdrop has helped the Jupiter China Fund, which is celebrating its third anniversary, achieve strong returns.

During the past year, the Fund has gained 117.7% compared with 87.4% for the MSCI Zhong Hua Index, the Fund's benchmark, and 76.8% for the IMA Asia Pacific Excluding Japan sector average*. This places the Fund 1st out 73 funds in the sector. Since launch on 23 October 2006, the Fund has returned 74.3% compared with 74.1% for the MSCI Zhong Hua Index and 46.5% for the IMA sector average, placing the Fund 5th out of 75 funds.

Ehrmann says: "China's economy has roared back to life in 2009. The prompt action of the Chinese government at a relatively early stage of the financial meltdown has translated into a recovery in confidence across industry and the populace. A State-induced surge in bank lending, Rmb4bn** of fiscal measures and a number of less-heralded market and structural reforms are likely, in my view to keep the country on track for several more years of strong trend growth.

"It appears likely that China will achieve an 8% rise in GDP for 2009 and we could see real GDP growth of 9% for 2010. Importantly, this growth is increasingly coming from the domestic economy rather than the export sector, supported by fiscal stimulus.

"We expect that the government will begin to step back and reduce the economic adrenalin it has been pumping into the system but there are encouraging signs that the consumer and private sectors are stepping up to the plate. Property transactions in terms of both volumes and price have recovered, as has retail activity, which is threatening to return to 20% year-on-year growth in certain areas.

"In a remarkably short period of time China has been able to change the character of its economy as a result of surging domestic demand for white goods and cars, driven by plentiful savings and government subsidies, the ramping up of already planned capital spending projects and, substantive reforms across sectors as diverse as healthcare, education, and the environment.

"Given the shift in its economy away from export led growth and towards domestic consumption, China may be heading for a current account deficit for the first time since 1993. However, given the size of its foreign currency reserves (47% of GDP**) this should not be viewed as an impediment. More importantly, with the world deemed to be operating at 85% of capacity, there are few signs of a major surge in inflation. As a result, I believe China is likely to continue to grow its economy at between 7%-9% for the foreseeable future. That said, the complexion of growth may change as the administration tightens its monetary and fiscal policies to ensure no crowding out of the resurging consumer and a recovering corporate sector.

"As the liquidity that has necessarily swamped the financial sector since the 4th quarter of 2008 begins to find its way into the real economy, financial assets are likely to lose one of their key drivers. This, in fact, has evidenced itself in the recent correction of the "A" share market. In addition capital raising, as reflected by a surge in high profile IPOs, is also draining the equity market of oxygen. However, there appear to be few signs of a material tightening of credit conditions. Consumers remain under-borrowed and cash rich. Operating margins appear to on the rise as input prices have fallen back and the economy expands.

"Against this backdrop, I expect earnings across many of the companies held by the Jupiter China Fund to grow by between 25% and 30%. Furthermore, valuations seem to me to be relatively attractive with respect to the growth prospects to be found across our portfolioof dynamic growth companies."

Two stocks that Philip has added to his portfolio following his trip to China are Hollysis Automation Technologies and Golden Eagle. Hollysis has been added to compliment Phillips current views on infrastructure development. As the infrastructure build out gains momentum there is an increasing need for "Chinese" solutions for certain key industries - nuclear and transportation being just two examples where expenditure is likely to balloon. Hollysis provides process control systems for these and other industries. The company is relatively unknown as reflected by the fact that currently it is researched by only two brokerage firms.

Golden Eagle has a very similar strategy to Nordstrom - the very successful US retailer as it broke out of the Pacific Northwest over 20 years ago. Golden Eagle seeks to dominate third tier cities in a particular region and become the only large high-end department store where they operate. They have a measured strategy of rolling out new units and have seen same-store sales grow over 20%.
"