Chan: The game is not to play on the index level, but stocks

China’s CPI growth slowed to 0.76% in January 2015 from 1.51% in the previous month, a further sign of the slowing economy. As part of its response, the People’s Bank of China has lowered banks’ deposit and lending rates by 25bp, the second interest rate cut in three months.

Against this backdrop, disinflation will be key for China equity investors in 2015, Ronald Chan, chief investment officer, equities (Asia ex-Japan) at Manulife Asset Management, tells The Asset in an interview.

China’s real interest rate is the highest in the world. Nominal interest rate is about 5%. But since inflation, as shown in PPI and CPI, is slowing quite sharply, real interest rate is likely to come down, says Chan.

Manulife also expects two more reserve requirement ratio (RRR) cuts this year. In China, the current RRR is about 18% to 20% of bank deposits, compared with 8% to 10% for global banks.

China maintains a high RRR to guard against hot money inflow. However, in view of some degree of outflow seen recently, there is room for the RRR to come down, Chan says.

He recommends five sectors that are beneficial to an environment of disinflation: property, information technology, telecommunications, utility and high-yield income companies.

Property companies have a very low base in the first half of 2014, and if taken along with the lower interest rate resulting from disinflation, the implication is that they will do well this year.

IT firms always come up new products for which they can charge higher prices. There’s 4G, the latest in the fast-changing world of wireless telecommunications. As China’s investment in 3G was limited, many users will migrate directly from 2G to 4G. This means that telcos’ cash-generating ability will be much better than that of other sectors.

The utility sector stands to benefit from China’s electricity reform, while high-yield stocks will thrive in the low interest rate environment.

Chinese retail investors believe that government support will push the market to break 3,000 points. “The upside is volatile, but it will still be gradually up. So the game is not to play on the index level, but stocks,” notes Chan.
Commenting on the impact of falling oil prices, he adds China is likely to benefit more than emerging Asian countries like Malaysia, which is a net exporter of oil. Commodity, oil and steel companies will be adversely affected, but certain sectors such as consumer staple and discretionary at the low end will gain from the situation.

Manulife was underweight China from the first half of 2014, then moved to neutral from middle last year, and is now overweight China equities.

Reforms
Chan believes urbanization as well as fiscal and SOE reforms will be the next themes in China, but investors should watch out for IPO reform, which will be unveiled towards the end of this year and is likely to be implemented in 2016.

“You will see more small and medium-sized enterprises coming to the market,” he says.

Meanwhile, the level of subscription will come down. Compared with the oversubscription rate of thousands of times for state-owned enterprises in past initial public offerings, the level for the latest round of over 20 IPOs was about 200 times, Chan notes.

So far, Manulife’s exposure to the Shanghai-Hong Kong Stock Connect is very low. This is because its funds are registered in Luxembourg and are still in the approval process.

As the largest player in Hong Kong’s Mandatory Provident Fund market, Manulife, along with the Mandatory Provident Fund Scheme Authority, is looking into whether the city’s MPF resources can be invested in the Stock Connect.