China's positive share price performance will continue to be driven mainly by upward earnings revisions, which will benefit the auto and property sectors in the country.
That’s according to Mandy Chan, head of China & HK equities at HSBC GAM.
‘The auto sector is an important component of overall retail consumption in China. The stimulus measures for autos announced by the government last year, including the lowering of the purchase tax on smaller vehicles to 5% from 10% previously, have helped to drive auto sales in 2016,’ said Chan.
‘Sales of passenger vehicles are up close to 7% YoY as at the end of April 2016. We are particularly positive on sports utility vehicle makers, as sales of SUVs have continued to be strong and are up close to 60% over the same period.
‘We believe the sales momentum of SUVs will remain strong going forward. With SUV sales currently accounting for 30% of the total auto demand in China, they may eventually make up half of the passenger vehicle market, similar to Korea and Japan.’
Besides auto sector, Chan is also upbeat about property sector. ‘The other bright spot is the property sector. While inventory is still a concern in lower tier cities, we have seen an undersupply situation develop in tier-1 cities since last year and surging property prices as a result.
‘We expect tier-2 cities in China to move into an undersupply situation from Q4 2016 onwards. Already, the transaction volume of tier-2 cities has risen by 30% in 2016.
‘We believe tier-2 markets hold the key to an inflection in national new starts which should help support a cyclical recovery in the economy, as these cities represent around 30-40% of total transactions and construction activity.’
Negative on banking
In contrast, Chan said she is relatively negative on the banking sector. ‘The Chinese banks are trading at 0.5-0.6 x price-to-book -- some of the cheapest valuations in the world. Valuations at these levels imply around 10% non-performing loans in the banking system, as compared with the less than 2% that the banks actually reported.
‘Chinese lenders have been maintaining a relatively high level of provisions coverage against NPLs over the past few years, sufficient to buffer an NPL level of around 3%. However, provisions coverage has been gradually falling with the ongoing build-up of NPLs.‘Looking ahead, the banking sector will experience a rough patch where earnings growth will be limited by rising provisions for bad debts. We believe the worst is yet to come. So we remain underweight Chinese banks and have re-routed those funds into our preferred sectors such as autos, property and technology in particular, as the sector has seen its weighting increase significantly in MSCI indices after the full inclusion of US ADRs in May 2016.’