China’s Industrial Rebound
By: Janus Henderson Investors
Harvest Exchange
September 19, 2017
China’s Industrial Rebound
At the start of 2017, many investors worried about a sharp slowdown in China. There were expectations that the country’s property market would soften and that the government would tighten monetary policy and rein in speculative investments and illegal activities. But economic growth this year has so far been surprisingly resilient. During the second quarter, China’s gross domestic product (GDP) rose by an annual rate of 6.9%, well ahead of most forecasts and above Beijing’s target of around 6.5% for the year. Even more interesting, much of that growth could be attributed to a rise in industrial output – or China’s old economy.
Strong economic growth and robust industrial production in China have broad implications for the global economy, as well as for investors. Is it sustainable? Charlie Awdry, Janus Henderson Chinese equities portfolio manager, shares his point of view.
What is driving China’s surprisingly strong economic growth this year?
We believe that China’s economic growth has been stronger lately because the cyclical improvement in Chinese corporate profits has exceeded analyst expectations, both in the size of the upswing and in how many different sectors of the economy have benefited. This upswing is due partly to the return of rising prices, in particular industrial prices as measured by producer price indices (PPI), helping commodity-driven sectors. Improving consumer confidence and expenditures, as well as product innovation and the rise of social media advertising in the Internet sector, have also aided economic growth.
Why has China’s old economy, which includes the industrials and materials sectors, delivered strong profits recently?
Although the old economy is expected to slow down, the companies that make up this segment – steel producers and packaging and paper manufacturers, for example – generally have delivered positive earnings during China’s August reporting season. State-mandated capacity cuts and environmental regulations have led to the shutdown of inefficient operations, improving the pricing and profit margin environment for many industries. We also believe analysts have underestimated the positive operating leverage that is coming through corporate income statements as a result of improving top line growth.
How sustainable is the rebound in industrials and other areas of China’s old economy?
Returns on capital employed and returns on equity in many of these old economy industries may have bottomed. In fact, these metrics appear to be improving, as companies have scaled back expansion plans and capital expenditure just as the economic cycle and cash flows improve. Currently, this is translating into higher dividends for minority shareholders. We think any sustainable improvement in return on assets in the current economic cycle would be a very bullish sign for China, so we continue to watch this closely.
For perspectives on how China and other factors are impacting global industrial growth, please see our latest Global Sector Views.
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Originally Published at: China’s Industrial Rebound
