![Michael Lai is investment director at GAM](https://www.theasset.com/storage/Image/2018/Jan/1516076036Michael-Lai_GAM.jpg)
THE Chinese New Year begins on 16 February 2018, when we enter the Year of the Dog, which in Chinese astrology symbolizes positive traits such as loyalty, honesty and faithfulness. The dog itself is also viewed as a lucky animal by the Chinese. It is thought that if a dog enters your house, it brings good fortune.
The question is, will the Year of the Dog be a good one for investors in China? Astrology aside, we can see a number of positive signs for China in the year ahead. The development of existing themes within the economy and the emergence of new opportunities provide investors with much to consider.
Off the leash
China continues to make the transition from its ‘old’ to a ‘new’ economy and it is fascinating to watch this take shape. In the year ahead, we believe that the main driving force of China’s new economy will continue to be domestic consumption, which has allowed the economy to successfully transition from its previous heavy reliance on the tertiary and manufacturing sectors.
Not only has the sheer size of domestic consumption been a surprise, its underlying trends and evolution have also been intriguing. Domestic consumption is being supported by rising income levels and urbanization as more and more of the population moves into the cities from the countryside. Urbanization tends to lead to higher wage levels, which in turn leads to an expanding middle class, with greater disposable income.
It is no surprise, therefore, that premiumization is one of the most prevalent retail trends at the moment. Companies are emphasizing the quality and exclusivity of their brands and it has not gone unnoticed by those with cash to spare.
For instance, Chinese middle-class parents are spending more on education, in the form of after-school tutorial activities. There is also a growing demand (to the point that supply is struggling to keep pace) for more highly priced, premium-brand liquor. And the appliance sector has also witnessed a significant change: customers are upgrading in droves from basic appliances to more sophisticated and costly goods such as voice-controlled air conditioners and refrigerators with smart features.
Looking a little deeper, the main source of domestic consumption as a pillar of Chinese economic growth appears to be the millennial generation, usually in the form of an only child from a family with a high level of savings and low household debt. Enabled by their higher wealth levels, the tendency is for the parents to shower the best on this child, buying progressively more expensive and higher-quality goods.
Premiumization has not just upgraded the population’s possessions; it has also boosted the corporate operating margins of listed companies participating in this marketing strategy.
Top dog
Technology companies have supported the spending boom, as they keep evolving to serve continuously changing consumer spending patterns: China is now one of the most developed e-commerce markets in the world, with digital purchases contributing a world-beating 18.4% of retail sales in 2016. Spending via mobile phones is growing so fast it now accounts for 56% of e-commerce sales. This has been enabled by infrastructure investments made by companies such as Alibaba and Tencent, which have been enhancing their payment systems, e-commerce platforms and logistical services. And while Chinese technology stocks have high valuations, they are well supported by rapid earnings growth. IT companies have been delivering earnings that outstrip even the most bullish consensus estimates. We therefore believe that the technology sector will continue to flourish in 2018.
Returning to the economic picture as a whole, President Xi Jinping’s strengthened position following the 19th National Congress last year cements his policy objective of the country achieving a “balanced and sustainable growth” path. One of the noteworthy developments from the Congress was the abandonment of specific GDP growth targets with the focus instead on long-term policy objectives. China is moving away from an economy that was characterized by rapid growth to one that is more focused on high-quality development. We view this as a positive move for the country, as it means the government will continue to address the fundamental imbalances in the economy in a more pragmatic fashion. In the meantime, our expectation for the year ahead is a modest slowdown in economic growth, from 6.8% to 6.7%, in line with the government forecast.
To sum up, we believe that the growth prospects of the economy continue to be positive, as the underlying fundamentals remain on solid footing supported by enduring consumption trends, the low levels of household debt and a high savings rate. Our view is that China today, well supported by a burgeoning domestic consumption sector, is worth considering as a long-term investment.