Riding the tailwinds of a Chinese recovery

The fast view

We expect a global slowdown to take root over the second half of the year, with developed markets the hardest hit.

China’s economy is recovering after lifting its Covid lockdowns. Stimulus measures and the reopening of its economy are underpinning growth.

While we’ve tilted our portfolio more towards defensives due to the challenging growth backdrop, a recovering China offers us exposure to attractive cyclical opportunities – both onshore and offshore.

O ngoing load-shedding and poor growth prospects are weighing on many of South Africa’s domesticoriented companies. Within this challenging environment, we are highly selective, gravitating towards companies with earnings resilience.

While we are experiencing tough market conditions, we believe the current environment will provide us with attractive investment opportunities to create longterm wealth.

Riding the tailwinds of a Chinese recovery

Tighter financial conditions have weighed heavily on equity markets. Last year was all about inflation, the interest-rate hiking cycle and how long it would take to peak. This year, investors are strongly focused on the growth outlook. But the full impact of high interest rates and the withdrawal of credit on growth and earnings expectations is yet to be felt. We expect a global slowdown to take root over the second half of the year, with developed markets the hardest hit.

China rebound after lockdown slumber

While the West has been cooling its economy to bring inflation down, China’s economy is recovering after lifting its Covid lockdowns. Stimulus measures and the reopening of its economy are underpinning growth. Over the first quarter of 2023, China’s economy expanded 4.5% (year-on-year), supported by strong growth in exports and infrastructure investment, and a bounce back in retail sales and house prices. Pent-up consumer demand is helping the economy rebound, thanks to excess household savings that accumulated during the Covid lockdowns.

While inflation is still sticky in many parts of the globe, both consumer and producer price inflation remain mild in China. This means that policy makers have more room to introduce additional stimulus measures to aid the country’s economic recovery – should the need arise. The Chinese authorities have signalled that they are relaxing their regulatory crackdown on big business, which for now has helped to create a more favourable investment climate.

Tapping into consumption-led growth

As active managers, we look to balance our defensive positions in the Ninety One Equity Fund with cyclical opportunities. While we’ve tilted our portfolio more towards defensives due to the challenging growth backdrop, a recovering China offers us exposure to attractive cyclical opportunities – both onshore and offshore. We tend not to focus on where stocks are listed but rather do a bottom-up assessment of where companies generate their revenues. Many of these global players are well positioned to continue receiving positive earnings revisions from better fundamentals in Asia.

A recovering China offers us exposure to attractive cyclical opportunities – both onshore and offshore.

We believe pent-up demand from Chinese consumers should benefit sectors such as luxury goods, financial services and retail. Luxury goods maker, Richemont – which is a key portfolio holding – is set to continue seeing positive earnings revisions as Chinese consumers spend excess savings. Recent results from LVMH and Hermès showed strong demand from Asian consumers.

Pent-up demand from Chinese consumers should benefit sectors such as luxury goods, financial services and retail.

Our positions in Alibaba (e-commerce giant), Bosideng International (China’s largest down clothing company) and Chongqing Fuling Zhacai (food firm operating in the Chinese appetizer industry), give us attractive exposure to consumer-led growth in China. Food services group Bidcorp and brewing giant Anheuser-Busch should also benefit from the ‘reopening trade’ as Asian consumers travel the globe and visit restaurants. The cost of sales and margin pressures that Anheuser-Busch experienced over the last 2 years are set to dissipate, and we anticipate an improvement in the company’s earnings forecasts above market consensus. Over the next 12 months, we expect Bidcorp to continue to enjoy positive earnings revisions, as the company profits from market share gains and increased efficiency.

Riding the tailwinds of a Chinese recovery

Riding the tailwinds

of a Chinese recovery

While Chinese consumers are spending more on leisure and luxury items, we anticipate that they will channel some of their excess savings into investments. The property market has stabilised, and investors are looking to grow their wealth by also investing in financial markets – not just real estate. To this end, we hold a position in a leading Chinese internet financial services platform, East Money Information Co. The firm provides securities, financial e-commerce, financial data and internet advertising services.

Tencent enjoying a recovery

With policy makers focusing on promoting growth in China, regulatory interventions affecting businesses (particularly technology) have eased in recent months. Consequently, the operating environment for technology companies has improved materially. Tencent has secured major video game approvals, which has allowed the Chinese tech group to build a strong gaming pipeline. This should support revenue growth over the next 1-2 years. Thanks to better economic growth in China, online advertising revenue has turned positive again, and we expect this momentum to carry through into 2024.

Tencent has secured major video game approvals, which has allowed the Chinese tech group to build a strong gaming pipeline.

We do not have a direct holding in Tencent but have a material exposure to this business through our overweight positions in Naspers and Prosus. Both companies are strongly focused on improving efficiencies and turning their loss-making businesses around by 2025 (classifieds, payments, fintech, food delivery and edtech). Share buybacks are also supporting Naspers and Prosus as management attempts to address the steep valuation discount.

Global diversified miners benefiting from tight commodity supply

BHP Group, with its large bias towards iron ore and copper, is well positioned for the demand uptick in China, as the country restocks its supply chains. Increased infrastructure spending demand is benefiting the global diversified miner, which is a top ten holding in the Ninety One Equity Fund

Selective exposure to SA Inc. stocks

The ‘SA Inc.’ universe (banks, retailers, insurers and industrials) are trading at valuation multiples well below their long-term averages. Ongoing load-shedding and poor growth prospects are weighing on many of the domestic-oriented companies. Tough economic conditions such as high interest rates, and rising fuel and food costs have eroded the spending power of South African consumers, making it difficult for some local players to generate sustainable earnings. Within this challenging environment, we are highly selective, gravitating towards companies with earnings resilience.

We continue to have a healthy allocation to select South African banks where earnings revisions remain positive, and valuations are very attractive. We have, however, largely sold our positions in discretionary retailers. Our exposure to local defensive businesses is mainly expressed through our holding in Shoprite, which continues to take market share with its dominant and growing presence across all the LSMs1 in South Africa – from Usave at the low end to Checkers at the upper end. The group’s leading supply chain is a key differentiator in the South African market and this, coupled with ongoing innovation, is supporting its growth trajectory in a tough environment.

We also like OUTsurance and Sanlam because of their attractive earnings profiles. Coming into 2023, OUTsurance is offering doubledigit top line growth, thanks to improved underwriting margins – both in South Africa and Australia. Continued market share gains are also benefiting the Australian business.

We also like OUTsurance and Sanlam because of their attractive earnings profiles.

A shift to global defensives

On the global front, we have materially increased our exposure to more defensive companies at the expense of cyclicals and growth stocks. Given increased risks of earnings disappointments, we have a preference for companies with more stable and sustainable earnings growth profiles, underpinned by strong cash flows. For example, within healthcare, our holdings include Elevance Health, United Health Group and Thermo Fischer. Despite challenging economic conditions in developed markets, these companies are still able to deliver double-digit earnings growth and attractive dividend yields. We have also increased exposure to defensive energy utilities with growing renewables businesses, such as NextEra Energy and Iberdrola.

The portfolio has a large active overweight position in gold miner, AngloGold Ashanti. Earnings expectations are being revised significantly higher on the back of a rising gold price. On the offshore side, we have exposure to Barrick Gold Corporation. We believe we are close to a peak in interest rates, which should benefit gold.

Conclusion

The effects of tighter monetary and financial conditions will take time to be fully reflected in growth and earnings expectations. With the developed world facing a growth slowdown, we are positioned to capture the cyclical opportunities that a resurgent Asia offers. Markets will likely remain volatile, with China facing a bumpy road to recovery. To mitigate risks and to capitalise on growth opportunities, we maintain a balance of exposures to defensive and cyclical stocks. Keeping an eye on changing earnings and growth expectations will be key.

Malcolm Charles Portfolio Manager, SA Fixed Income

The fast view Load-shedding, poor economic growth and soaring interest rates are weighing on investor sentiment.

While you can’t wish away the steady stream of bad news, what you can do is avoid getting emotional with your investments.

Fortunately, it’s not all bad news, there’s some improving news too. Eskom is on a better financial footing, the restructuring of the power utility is gathering pace, and the inflation and interest rate outlook has become more favourable.

SA government bond yields remain attractive versus emerging market bond yields, domestic cash rates and inflation, more than compensating investors for the risk they assume.