China’s long-awaited market rally has occurred in tandem with a broader move into emerging market stocks after US avoidance of an imminent “fiscal cliff” and strong rhetorical support from ECB President Mario Draghi for peripheral Euro-zone sovereign bonds.

This has encouraged many investors to take a more risk-on approach to asset allocation. But do these developments presage a fully-fledged return to equities in 2013 or is the recent rally for stocks more of a short-term response to some skillful can-kicking by politicians? That is the question many equity investors are asking.

In terms of China the change in sentiment is unmistakable, although investors need to draw a distinction between the cyclical recovery taking place and some of the structural factors at play – which paint more of a complicated picture. The evidence for a cyclical recovery in China’s economy has been rounded out by a bigger-than-expected 10.3 per cent increase in industrial output in December and a 20.6 per cent increase in fixed asset investment in 2012.

On a regional basis, this has prompted some investors to take profits on South East Asia stocks (which have had a good run on robust fundamentals in the past year or two), and rotate back into China.

Brighter outlook

In addition to the more positive economic data, last year’s China leadership election removed political uncertainty from the market and raised expectations for more reform in the months and years ahead. A brighter outlook for Chinese equities has also been assisted by a series of measures from regulators designed to curtail supply and bolster demand for stocks.

Another helpful development for China stocks has been falling popularity for wealth management products amid a recent fall in yields and in the wake of several highly publicised blow-ups.

In an effort to diversify their revenue from a traditional focus on lending and deposit taking, many mainland banks began to offer wealth management products, enticing investors with yields of 5-7 per cent.

However, a lack of transparency about where the assets involved are invested, some high profile miss-selling scandals, and the simple fact that yields have fallen from their highs, have resulted in falling demand for these products and a refocusing of investor attention on equity markets

Headwinds and tailwind

Against these positive drivers for stocks, investors must also consider some headwinds. Perhaps the biggest of them all is the structural shift by China’s leadership to rebalance the economy towards consumption and away from investment.

Although we believe that this is a long-term positive (moving up the value chain, a rising middle class, more quality of growth and less dependence on external demand etc.) it does mean that in the short-term at least, annual GDP growth will likely stay below the double-digit rates seen in the past decade.

Again, China’s move to bolster domestic consumption (benefiting consumption-related stocks at the expense of infrastructure and export plays) will likely be supported by greater efforts to spread wealth (in line with the 12th 5-year plan) and an acceptance of faster wage growth – which will negatively impact corporate profitability all other things being equal

On balance though, we believe the long-term secular drivers in China, combined with the current cyclical recovery in China and lessening of political risk in the Euro-zone and the US, make China equities an attractive investment destination in 2013.

Gareth Nicholson is a senior investment commentator at Fidelity Worldwide Investment
19th February 2013
Source:  Professional Planner    http://www.professionalplanner.com.au