According to market consensus, China’s economy is likely to reach the trough in the first half of 2019. On the monetary front, liquidity conditions have improved on the back of several Reserve Requirement Ratio cuts and Medium-term Lending Facility injections. The interbank interest rates have been softening, with three-month SHIBOR standing at 2.90% on Jan 31, compared to 3.35% by the end of 2018¹. Moreover, more corporates bond issuances have been approved to deal with the tightened liquidity that pressured the corporate sector, especially the private corporates, between 1Q18 and 3Q18. However, the ample interbank liquidity has not materially filtered through into the real economy to support growth yet, given financial institutions’ generally weak risk appetite and capital constraints.

Total Social Financing(TSF) is a reasonable gauge of credit extended by China’s domestic financial system to the private sector which includes off-balance-sheet financing that exists outside the conventional bank lending system, such as initial public offerings, asset-backed securities and bond sales. The aggressive de-leveraging initiatives through New Asset Management Rules in 1H18 has substantially curbed the expansion of shadow banking that used to be a major source of funding for small and medium-sized enterprises, resulting in the choking-off of the off-balance-sheet funding in TSF. A more robust revitalization of TSF requires decisive relaxation in the implementation of New Asset Management Rules and we learnt that the regulators are leaning towards taking a softer approach. Hence, the off-balance sheet part of TSF will be a key checkpoint that we watch for a confirmation of the bottoming of the real economy.

China’s TSF rose to 1.59 trillion Yuan in December 2018 from 1.52 trillion Yuan in the previous month¹, but growth of outstanding TSF slowed to an all-time low of 9.8%².  As mentioned above, the de-leveraging efforts were the initial culprits. However, from our on the ground research, we believe that this phenomenon was further complicated by the fact that many Chinese corporates have fallen into an inventory buyer-strike amid trade uncertainties, leading to weak credit demand. However, we are beginning to see the light at the end of the tunnel as the weak credit supply problem is being addressed by various means, including administrative ones and supplementary policy tools. The People’s Bank of China (PBoC) has introduced the Central Bank Bills Swap (CBS) in January, which should help to enhance the attractiveness of banks’ perpetual bond issuances. With the facilitation of this swap program, banks’ capital constraints could hopefully be alleviated albeit the efficacy of credit creation would still take some time to crystallize. According to the latest data released by the PBOC on Feb 15, growth of outstanding TSF picked up to 10.4% in the first month of 2019, with Chinese bank lending hitting record high of 3.23 trillion Yuan², which may indicate that the previous policy push is beginning to take hold.

On the demand side of the credit creation, an interim solution of the trade talks between China and the US would hopefully help shore up business confidence and revive loan appetite. We are sanguine about the outcome of the trade talk as we believe neither side can afford a deadlock upon the expiry of the current truce, let alone a full-fledged breakdown of the negotiations. There are a lot of noises along the negotiating process, but the key is that the economic and political stakes are too high for both sides to drag on such a skirmish.

Despite this “hard-to-predict” environment, we will focus on three major areas to look for long-term winners: 1) strong long-term earnings capability and visibility; 2) decent free cash flow yields ; 3) significantly discounted short-term (3-6 months) valuations caused by sentiment overshooting on the downside driven by market worries. Most importantly, while the market volatility will remain for a while, we are not short of investment candidates that meet the above criteria. We will not hesitate to pick up those opportunities in the near future and we believe the next 2-3 months would be a very critical period for our funds to accumulate those industry leaders with strong core competences and good visibility.

[1] Source: Bloomberg, as of Jan 2019

[2] Source: Reuters, as of Feb 2019

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

The off-shore China markets as represented by MSCI China and Hang Seng China Enterprises Index showed a technical bounce in November as investors expected some positive developments from the Xi-Trump meeting in early December.  It’s interesting to note that in contrast, the Shanghai Composite Index edged down slightly, highlighting that domestic investors’ sentiments were still being dragged by the weak economy and the continued tight liquidity, especially for private enterprises, in China.  From recent policy developments, we can see that the Government is expanding financial support for the real economy and shoring up confidence in the private sector.

More credit supply for the real economy

There is a rather disturbing phenomenon on the corporate financing front – despite of loosening liquidity, credit impulses are still weak.  The liquidity in the system has not been translated into credit for the real economy, especially for private and small/medium sized enterprises.  One of the major reasons is that, as part of the financial sector reform efforts, the Government imposed a rather stringent rule on credit officers of the state-owned banks called the “life-long responsibility” system.  This means that a credit officer would be held life-long responsible for any bad loans he has made during his tenure.  This was a rather drastic move by the Government who was trying desperately to rectify the lack of credit process in the banking system, if not corruptive practices, within a short period of time.  The immediate backfire was credit officers effectively going on a lending strike.  However, the latest development we have learnt is that the Government has subtly changed this policy of “life-long responsibility” to “exempted responsibility after due credit process”. This means that so long as the credit process is strictly adhered to, the credit officer would not be held responsible even if the loans go wrong afterwards.  We think that this approach is a lot more sensible.  Obviously, this change still needs some time to filter through the system; nevertheless, this is a positive change at the margin despite generally weak credit demand which may continue until more trade-war clarity is established.

More tax cuts on the way

On December 18, China Daily reported that more tax cuts are on the way to boost domestic consumption and revitalize  private enterprises. According to a senior official from the State Administration of Taxation, personal income tax reduction will be the Government’s top priority next year, coupling with tax exemptions for SMEs and high-tech companies. Based on the plan promoted by the Ministry of Finance, the market predicts that next year’s tax cuts may reach 1.5 trillion yuan ($217.5 billion), 200 billion yuan more than 2018¹. The state news site also reported that a researcher with the Chinese Academy of Social Sciences, Zhang Ming, said it is likely the government will further cut the VAT by 2% in 2019¹. The tax cuts which we and some market participants have been expecting seem to be quite imminent and will in time provide an important relief to the economy and investor sentiment.

Less restrictions on real estate developers to issue bonds

Most recently, the National Development and Reform Commission has relaxed the restriction on big real estate developers (with annual sales exceeding Rmb30bn) to issue bonds².  We think that this is a very positive policy signal as the Government has effectively given up on their one-size-fits-all crackdown policies in the property sector.  We have taken the view for a long time that underlying demand of residential properties is still healthy, but in certain cities, prices might have been rising too fast therefore soliciting Government interventions. Nevertheless, we don’t think this warrants an across-the-board crackdown as we have emphasized that China’s real estate isn’t a one single market but consists of hundreds.  What we have learnt from the local governments is that they are now subtly given more flexibility in determining their own fine-tuned policies on residential properties.  As such, we think that one more downside risk to the economy is contained.

Looking ahead, we are closely watching the effect of global central banks shrinking their balance sheets at the same time in 2019.  Also, we realize that it takes time for measures like tax cuts to filter through to the economy, as such, the Chinese economy and individual companies may still release relatively weak figures, resulting in some volatility in early 2019.  That said, we have definitely turned less bearish and believe that the backdrop for our stock picking efforts has notably improved.

[1] Source: China Daily, as of Dec 2018

[2] Source: NDRC, as of Dec 2018

Disclaimer:

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. You may lose part or all of your investment. You should not make an investment decision solely based on this information. If you have any queries, please contact your financial advisor and seek professional advice. This document is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.