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January 2019 | GSAM Connect

EM Viewpoints – China Equities: Medium-Term Opportunities in the Middle Kingdom

China’s growth is moderating in the near-term... China’s economic growth is decelerating as a result of both near-term cyclical challenges and structural shifts. Cyclical headwinds include infrastructure slowdown due to deleveraging, a moderation in consumption growth and private capital expenditure as well as trade tensions. In our view, the structural shift to an economy that is increasingly driven by private consumption and innovation, from one previously reliant on exports and investment, is also tempering growth in the short-term. We believe accommodative monetary policy and active fiscal policy could help cushion internal and external headwinds.

... But medium-term fundamentals look attractive. We believe a combination of the secular transition to consumption-driven growth, push towards domestic innovation and government focus on ongoing reforms should drive strong medium-term fundamentals. We expect the structural shift towards consumption and innovation to drive more self-sustaining long-term growth, despite the near-term moderation. Progress made on various reforms has been instrumental in improving long-term economic fundamentals and market efficiency. Trade frictions may further incentivize policy focus on both internal reforms and a more open economy and capital market.

Robust fundamentals present attractive investment opportunities. We see a compelling and diverse investment opportunity set in light of the sanguine medium-term outlook, and leveraging our deep understanding of the China equity market and its differentiating characteristics. We are constructive on “New China” opportunities created by online and offline integration; technological innovation, higher-value manufacturing and import substitution; reform and regulation; as well as winners of consolidation in the “Old China” segment.

We believe investors are currently under-allocated to Chinese equities. Relative to its share of global population, economy and trade, China is currently significantly underrepresented in the global equity benchmark, comprising only 4% of the MSCI All Country World index. China’s weight in the MSCI EM Index is poised to increase from the roughly 30 % currently to roughly 42%, as MSCI plans to expand the portion of onshore A-shares in the Index from the current 0.8% to potentially 16.2%1. Meanwhile, A-share valuations have fallen to near 10-year lows and are now trading at a significant discount to their historical average and to Developed Market (DM) equities. As such, we believe investors should consider increasing their allocation to Chinese equities, using one of several options:

  • Add A-share equities to existing EM equity allocation
  • Add all-China equities to existing EM equity allocation
  • Invest in a standalone all-China equity allocation and an EM ex China equity allocation
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