China’s economy not as weak as headline numbers suggest

China’s economic growth moderated to 6.4 percent in the fourth quarter, its slowest quarterly pace since the global financial crisis. The full-year growth rate for 2018 fell to just 6.6 percent, the lowest since 1991. A number of the factors behind this slowdown, such as the trade dispute with the US and policy curbs on excessive leverage, helped make Chinese equities one of the worst-performing asset classes last year.

Looking ahead, however, we see several reasons for a cautiously optimistic stance in 2019:

Economic green shoots. Although the headline growth figures are trending weaker as expected and most data are still hovering at historical troughs, there are signs of stabilization in some activity data. Fixed asset investment (FAI) annual growth has stabilized at a 5.9 percent rate, and the infrastructure component of this is already rebounding — from -4.3 percent in the third quarter to 5.7 percent in the fourth quarter. This helped to push up overall FAI from 4.6 percent to 7.5 percent in the fourth quarter, despite softening property investment. Retail sales edged up in December (8.2 percent year-on-year), and auto sales growth was less negative than the previous month.

Building up to a deal. Public rhetoric and media leaks on trade posturing indicate diplomatic progress. US President Trump on Saturday told Reuters “a deal could very well happen with China.” Other reports suggest that the US is seeking compliance checks on China's progress on trade reform as part of a deal, suggesting a possible path out of the current impasse. Chinese Vice-Premier Liu He's planned visit to Washington at the end of the month adds to the optimism.

Policy support ramping up to prevent any hard landing risk. While the Chinese government did not intend to introduce massive stimulus, it has ramped up its efforts to ease policy as the economy has weakened. The central bank has announced a 1 percentage point cut to its reserve requirement rate (RRR), and we anticipate another 100–200 basis points of cuts later this year. Beijing is also likely to pursue a more proactive fiscal policy, including infrastructure build-out and additional tax cuts. Additional RRR cuts, less restrictive shadow credit controls and higher local government bond issuance should lead to increased bond financing, stabilization of shadow credit, and stronger bank lending growth. So despite the slowdown, we continue to prefer Chinese equities within our Asia portfolios. MSCI China's 12-month-forward price-earnings ratio is 10.1x, a significant discount against its 15-year average of 11.5x. At UBS, we maintain our overweight on global equities, but also hold a number of countercyclical positions to help navigate market volatility.

Courtesy: UBS Chief Investment Office