Mark Williams

Will the Year of the Dog be investors' best friend?

Mark Williams

The Chinese New Year begins today, marking the start of Spring Festival and ushering in a new animal sign in China’s 12 year zodiac cycle. Here we take a brief look back at the Year of the Rooster and examine the outlook for investing in China in the Year of the Dog.

The Year of the Rooster was good to Chinese equities


The MSCI China Index has returned 32% in sterling terms since 28 January 2017, the start of the Year of the Rooster, while the MSCI Asia ex-Japan Index has risen 20%. This compares very favourably with the 6.4% performance of the MSCI World Index of developed markets and the 4.9% return from the UK’s FTSE All-Share.

Investors in Chinese internet stocks had most to crow about

It might have been more fitting for last year to have been the Year of the BAT given the extent to which stockmarket leadership in China/Asia came from Chinese internet companies.


In the US you have the FANG stocks – Facebook, Amazon, Netflix and Google (now Alphabet) – and now the growth of China’s own IT sector has justified the coining of its own acronym: BAT – Baidu, Alibaba and Tencent. The FANG stocks have notched up stellar returns over the last year. These four stocks alone account for 13% of the investment return of the 632-member MSCI USA Index since 28 January 2017 (+18% in local currency). It has been an even more emphatic story of IT dominance in China; the three BATs accounted for about half of the rise in the 152-member MSCI China index in the Year of the Rooster (+47% in local currency).


Following these gains, shares in the BAT companies sit on lofty valuations and in our opinion have got ahead of themselves. We will be looking for market leadership to come from elsewhere in the Year of the Dog. We run an income fund so struggle to justify investing in expensive stocks with a lack of decent dividend yields. The type of companies we own – those that provide a healthy balance of earnings and income growth – tend to come into their own when investors become less sentiment-driven and more discerning. With the Chinese economy set to continue decelerating in future years, this profile could prove very valuable.

We saw improving company earnings, a benign economic backdrop and less concerns over a crisis

Last year we perceived a growing acknowledgement that China is not teetering on the edge of a crisis. Having stabilised in 2016, fears of rampant capital flight remained absent. In 2017, attitudes in Asia also suggested that China’s high debt levels were no longer causing significant concern.  This possibly reflected investors’ realisation that a lot of loans are from government controlled entities, to government controlled entities, meaning they can be unwound without too many negative side effects.


This allowed investors to focus on a significant recovery in corporate earnings which was supported by a better-than-expected economic backdrop. Growth did not tail off much in the second half of the year and although inflation rose slightly, it did not reach levels that concerned markets.

What prospects for the Year of the Dog?

Despite their strong 2017 performance, Chinese equities still look good value. The Hang Seng China Enterprise Index – which represents ‘H’ shares in Chinese companies that are listed in Hong Kong – trades on a forward price/earnings ratio of 7.4. This compares against the US market (MSCI USA Index) on 16.9x and Europe (MSCI Europe Index) on 13.9x.

While the economy decelerates the investment opportunity is expanding.

China’s GDP actually rose by 6.9% in 2017, up from 6.7% in 2016 – but this was the first time in seven years that growth had accelerated. The growth rate is expected to revert to close to 6.5% this year, a level which is still very high by global standards and maintains China’s position as the regional growth engine.


Although its economy is decelerating, we believe the investment opportunity is expanding for those who are able to differentiate between the companies that will benefit from the economic transition and those that stand to suffer.


Earlier in the economic growth phase, it was tempting for companies to reinvest all earnings in the hope of compounding more growth. As China’s economy moves to a less aggressive growth phase, we believe that companies will begin to take more considered capital allocation decisions – investing for growth when appropriate while hopefully showing more inclination to return excess cash to shareholders. On aggregate, we expect free cash flow – cash generated by a company’s operations once capital expenditure needs are accounted for – to increase as past years’ heavy investments begin to mature. This will mean more cash is available to be returned to shareholders, which should provide ample opportunities for income investors given the country’s improving dividend culture.

The need for economic rebalancing (and deceleration) is increasingly understood

At the 19th Party Congress last year, China’s Communist Party prioritised ongoing economic rebalancing and more sustainable growth for the next five years. This stance is encouraging as, in our view, China need to rebalance its economy away from inefficient industries. Importantly there was also a move away from the Party’s old habit of announcing GDP targets, which have sometimes led to unhelpful decisions (and dubious data). That it was able to make this change with so little fuss suggests that there has been a shift in investor perceptions regarding the Chinese economy, with deceleration seen as acceptable in order to move to a more sustainable long-term growth path.

But you still need to avoid stocks exposed to slowdown and overcapacity…

So we avoid areas of overcapacity and falling returns, shunning moribund industries that are being propped up for employment rather than profit.

.. and target the long-term winners from economic transition

As China weans itself off its pursuit of growth at any cost, the country’s personal consumption continues to grow at a double digit rate. There are lots of companies generating earnings growth from this expanding middle class.


The Liontrust Asia Income Fund’s consumer-related exposure (consumer sector stocks as well as companies in other sectors exposed indirectly to consumer demand) stands at over 50%, and around a quarter of this is invested in China and Hong Kong.

Beyond the Year of the Dog

We of course invest with a long-term time horizon and here we find that China’s growth prospects are huge. This potential is widely recognised, but perhaps underappreciated is the extent to which this process is in its infancy. For example, we are already seeing Chinese consumption power have a huge impact globally through the 122 million Chinese who travelled overseas (in 2016), but 90% of China’s population still don’t own a passport. Similarly, China is the world’s largest auto market, with car sales exceeding both Europe and the US, but there are still only around 21 motor vehicles for every 100 people (based on 2017 Ministry of Public Security data), compared to almost 80 in the US (source: World Bank 2010). We shouldn’t make the mistake of thinking that the substantial consumption growth that has already fed through is anything more than the tip of the iceberg.

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

Investment in Funds managed by the Asia team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation.  The Fund invests primarily in Asian companies, which may be less liquid than companies in more developed markets.


This content should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy.  It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.
Friday, February 16, 2018, 10:11 AM