The Chinese economy as a whole is slowing but domestic consumption is still relatively strong, says Dale Nicholls, manager of Fidelity China Special Situations PLC
China experienced a worse 2018 than many other global stock markets, with a longer and deeper correction hammering share prices by almost 25% over the year. This combined with an ongoing economic slowdown could lead investors to wonder if China is a market to avoid for now. But a look behind the headline numbers reveals a powerful domestic consumption story which, when combined with rock bottom valuations, presents an attractive environment for stockpickers.
One of these stockpickers is Dale Nicholls, manager of the £1.4bn Fidelity China Special Situations PLC. His strategy is to leverage Fidelity's well-resourced analyst team in Asia to find opportunities across China that are not fully recognised by the market. In particular, he focuses on companies with strong brands, pricing power and good growth prospects. An effect of his unconstrained and research-focused approach is that his portfolio has a bias towards the small- and mid-cap names which tend to be overlooked by other investors. This strategy has helped drive the investment trust to top-quartile performance in its sector over both three and five years, according to FE data.
China gets richer
The portfolio's overarching theme is consumption, which Nicholls points out is the biggest driver of growth in China: "As the middle class develops, we're seeing increasing ‘premiumisation' which shouldn't be a surprise as incomes rise," he explains. "It is still the main theme I am backing as it is a pretty clear road forward in growth for the next 10 to 15 years."
Yet even Nicholls remains concerned about the impact of the slowing Chinese economy on domestic consumption. He concedes debt growth has been slowing at the margin and the US/China trade spat has weighed on sentiment. He notes the main impact has been on big-ticket consumer goods. The auto sector, for example, saw a 4% decline in 2018, its first negative year in two decades: "There is some slowdown on the consumption side, but if you look at things on an absolute basis you can see overall retail sales are still growing at a rate of high single digits, and consumption is still growing faster than overall GDP so, for me as a bottom-up stockpicker, it's still a healthy environment".
However, importantly the portfolio is well insulated from the effects of trade tariffs on Chinese goods because of its minimal exposure to exporters - some 90% of the total revenues of the companies in the trust come from Greater China.
Local brands on trend
Strong brands are an important part of the domestic consumption theme, and an interesting shift is happening as local Chinese brands become more desirable, giving Western names like Nike, L'Oreal and Starbucks a run for their money. For example, local smartphone handset makers in China are competing successfully with Apple on spec and price: "That price/ performance balance is shifting to the local players," Nicholls says