While China is without question the growth driver and the outperformer among Asian emerging markets, it’s clear the country is transitioning toward slower growth because of demographic factors and domestic rebalancing. In our view, China is entering a multiyear period of slower growth, but we consider its future growth robust and sustainable when compared with overall global gross domestic product (GDP) growth -- albeit below the annualized pace of more than 10% China experienced from 2001 to 2010.
Short-term: Transitioning to a slower growth rate
China’s improving cyclical data have mitigated fears about a hard landing. The negative revisions we observed during the second quarter have subsided, and this year’s growth is likely to end up in line or slightly higher than the government’s 7.5% target. In fact, China posted third-quarter GDP growth of 7.8%,1 due primarily to stabilization in its domestic economy and increasing export demand.
Long-term: Anticipating positive results from reform
Over the long term, it’s important for China to implement structural reforms to boost underlying productivity growth and help sustain healthy growth. Details about China’s reform efforts — including fiscal and land reform and liberalization of the financial sector — are expected to emerge from the Third Plenary Session of China’s Central Committee in November. While these measures may not provide cyclical support for short-term growth, we believe they’ll yield positive results over the longer term. It’s also encouraging that China is implementing these improvements without loosening monetary or fiscal policies.
Third-quarter performance: EQV strategy pays off
Our earnings/quality/valuation (EQV) strategy of adding high-quality Chinese stocks with appealing valuations — despite negative GDP revisions — worked in our favor during the third quarter. An example is the strong performance of Baidu, China’s dominant Internet search engine, a 2.20% in the Invesco International Growth Fund, as of September 30, 2013.2
We first purchased Baidu in June 2012 because its attributes at that time satisfied the earnings and quality attributes we seek, including:
- Revenue growth of more than 30%.
- Earnings-per-share growth of at least 20% over three years.3
- A strong balance sheet.
- Favorable shareholder returns.
- Cash-generative business model.
And, while its historical next-12-month price-earnings ratio of 30x4 would have been too expensive for our valuation criteria, undue concerns about company fundamentals made valuations more attractive, so we took advantage of that situation to buy the stock. We increased our holding when the stock began to weaken further following additional unfounded concerns about China’s economic growth, pressure on operating margins given large-scale investment in mobile, issues related to the corporate structure of Chinese-listed companies and fears about increased competition.
Baidu was up 64% for the third quarter.5 We anticipate an opportunity to increase exposure to Chinese stocks in line with our discipline when macro concerns lead to lower valuation of high-quality names that, like Baidu, promise growth and have a sustainable competitive advantage.
1 Source: Chinese Government
2 Holdings are subject to change and are not buy/sell recommendations.
3 Source: Factset, Invesco
4 Source: Factset. Price-earnings ratio is a common valuation metric for stocks that compares a stock’s share price to its per-share earnings.
5 Source: Bloomberg, L.P.
General risks :
China remains a totalitarian country with the following risks: nationalization, expropriation, or confiscation of property, difficulty in obtaining and/or enforcing judgments, alteration or discontinuation of economic reforms, military conflicts, and China’s dependency on the economies of other Asian countries, many of which are developing countries.
The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.
Invesco International Growth Fund risks :
Depositary receipts involve many of the same risks as a direct investment in foreign securities, and issuers of certain depositary receipts are under no obligation to distribute shareholder communications to the holders or to pass through to them any voting rights with respect to the deposited securities.
Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified funds.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
Many countries in the European Union are susceptible to high economic risks associated with high levels of debt, notably due to investments in sovereign debts of European countries such as Greece, Italy and Spain.
The investment techniques and risk analysis used by the portfolio managers may not produce the desired results.
Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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