Focus on emerging industries and cost performance under L-shaped economy

The L-shaped economic trend in China will last for a certain period and will not end in just one or two years, indicated by an “authoritative figure” in an interview of the People’s Daily in May.

How should investors seize the potential chances existing in the L-shaped economic trend? In an interview of the National Business Daily, Liu Yuhui, professor from Chinese Academy of Social Sciences, listed the bullish sectors of A-share market resulted from each demand structure change since 2002 and stated that industrial field had experienced the L-shaped trend long ago and the current chances still lie in entertainment, big health, technology, media and telecommunications (TMT) and other sectors which meet consumption upgrading structure. “But whether it is suitable for investment will depend on cost performance.”

Avoid industries with high pollution, high energy consumption and overcapacity but to develop strategic emerging ones under L-shaped economy

An “authoritative figure” stated in a recent interview of the People’s Daily that China’s economic trend will be “L-shaped”, rather than “U-shaped”, and definitely not “V-shaped”. The judgment of economic trend is undoubtedly an important tone in the authority’s remark.

When compared with other types of common economic trend, what are characteristics of the L-shaped trend and how to exactly comprehend it?

“The L-shaped trend is a concept lasting for a period. China’s economy declined since the first quarter of this year but there are signs that it will get stabilized. The 6.5-7.0 percent economic growth will sustain for a certain period and it is not a big deal as long as the figure does not continue to drop.” said Liu Tao, senior researcher at the financial research center from the Bank of Communications when receiving interview of the National Business Daily.

In the opinion of Liu Tao, “It may take a period to see the effects of structural adjustment of supply side and demand side. In terms of demand side, the moderate and loose monetary policy since last year and robust fiscal policy are able to keep the growth from further slipping. But the economic growth may not rebound to a high level until the supply-side reform takes effect. This can be interpretation on the L-shaped growth.”

The journalist noticed that it is supposed to be the time that China is experiencing the lowest economic growth now, said Liu Shijin, former deputy director of the State Council's Development Research Center, in the recent macro-economic situation analysis conference for the first quarter of 2016. Although China’s economy will not show remarkable rebound after falling to the bottom, the economic growth will not be further lower. China is likely to go the L-shaped trend with slight fluctuation. The L-shaped economic trend, if lasting for 5-10 years, is good for China to accomplish the medium and long-term development goal.

Under the L-shaped economic growth, what kinds of industries or enterprises may be exposed to risk that investors had better to avoid and what kinds of industries or enterprises might boast more opportunities?

Liu Tao told the journalist that “as to macro-perspective, industries that investors should avoid must be those with high pollution, high energy consumption and overcapacity”. This is the target of de-capacity. The economy turns better slightly now. If the overcapacity industries such as iron and steel, cement, glass and electrolytic aluminum resume production and expansion, severe problems may occur in the second half of the year.

In addition, it is not appropriate to develop low-end manufacturing now. At present, China’s demographic dividend is weakened and the Lewis turning point has appeared. Transfer of rural surplus labor is limited. If China continues to develop the low-end manufacturing, labor cost will be much higher than that in countries in Southeast and South Asia, where the low-end manufacturing is transferred. Salaries in these countries may be less than half of those in China.

When speaking of industrial opportunity, Liu Tao pointed out that “it is suggested to encourage developing strategic emerging, intelligentized and hi-tech industries of those with export superiority such as high-speed rail, extra-high voltage and the third-generation nuclear technology.”

Investment opportunities: focus on cost performance of sectors like entertainment, big health and TMT

Frustrated by the claim of L-shaped economic trend to some extent, the A-share market kept declining last week. On a weekly-base, the SSE Composite Index suffered a plunge of 2.96 percent, while the smaller Shenzhen Index and the ChiNext Board Index dropped by 4.41 percent and 5.87 percent, respectively. The SSE Composite Index even had its weekly moving average line dropping for four consecutive weeks for the first time in two years to around 2,800 points. What’s the future trend of the market?

For investment opportunities under L-shaped economy, Liu Yuhui stated frankly during the interview with the National Business Daily that we actually are already experiencing the L-shaped economy now. The course is obvious from the perspective of industries. No matter towards which direction industries develop, it is decided by the changes of supply and demand. “An economy will surely experience drastic changes of overall demand structure along with the rise of its average per capita income. It almost plays a decisive role.”

In the eyes of Liu Yuhui, as to the financial market, the stock market, for example, is quite efficient in understanding industrial development. Liu Yuhui divided the A-share market from 2002 into three stages.

The first stage refers to the 2002-2007 period. “China rapidly realized industrialization during this period. It will be easier to understand if the time is extended. During the bullish market in 2007, stocks engaged in heavy chemical and capital-intensive industries recorded the most outstanding performance.

For example, stocks involved in bulk commodities, energy, non-ferrous metals and etc. grew by dozens of times. And that was in line with the demand structure in China at that time. The prices of bulk commodities, energy, non-ferrous metals and coal all skyrocketed during the 2002-2007 period. The price hike stimulated enterprises to expand capacity since the money-making effect lured people to make great investment in these areas.”

The second stage is mainly seen during the 2009-2012 period. “China saw the worst-ever inflation in these four years. The inflation was mainly associated with asset price, referring to price of land and real estate. The real estate industry saw the fastest growth from 2009 to 2013. The sky-rocketing development of the industry in this stage greatly boosted relevant industries like home decoration, household appliances as well as food, clothing, housing and transportation -- basic necessities of life, and directly changed the structure of consumption demand.

Though the A-share market did not show sound performance in this period, many stocks related to general consumption surged by several times. Price hike usually comes along with the course of consumption mainly driven by certain products, and it is also a course for these industries to see improving concentration ratio. In this stage, general consumption stocks were deemed as growth stocks and their compound annual growth rate was around 20-30 percent.”

The third stage is seen after 2013 when consumption structure changed again and China became an economy with above average income. “It can be obviously seen that the consumption structure in this period changed. Industries like entertainment, big health, TMT, private wealth management and Internet finance started to rise. Actually, it is a process of price hiking. From 2013 to now, listed companies engaged in these industries are mainly middle and small-cap stocks. The bullish market experienced by middle and small-cap stocks since 2013 was associated with the aforesaid consumption and structure upgrading.”

So, what are the investment opportunities under current L-shaped economy which experiences industrial upgrading reform? How to seize the opportunities under current stage?

“Industries do not change much under current stage. And the direction (referring to the consumption structure formed from 2013) will last for very long time. But to financial asset, price and cost performance play a decisive role in the decision-making for investment”, as further analyzed by Liu Yuhui.

(XINHUA FINANCE)