Christina Chung, senior portfolio manager of the Allianz RCM China Fund, suggests that, while China’s prospects for economic growth in 2009 appear to be well supported, the upside potential for the equity market could be capped by poor earnings visibility. 
 
China’s economy is in the middle of a long-term transition from export-oriented growth to domestic-led expansion as the global economic downturn takes its toll on Chinese exports. 

Domestic consumption shows strong potential to be the next growth driver in the years to come, given a rising level of income per capita, a high household savings rate and a relatively low share of consumption as a percentage of GDP.  Yet this transition could be hindered by income disparity, a high tax burden and budding social security system, all of which require policy support.  Policy changes will take time to be implemented and the effects will gradually feed through to the real economy over the long-term.
 
Against this backdrop, we believe that fiscal and monetary policy will remain on course in 2009. Expansionary credit policy will also provide support, as was evident in the exceptionally strong credit growth in the first quarter of this year. 

China is in a relatively strong position in the current downturn as its banking system is healthy with a strong capital position, a relatively low ratio of non-performing loans, liquid balance sheets and low loan-to-deposit ratios. There is also ample capacity for Chinese banks to function as financial intermediaries, channelling domestic savings to borrowers.
 
Overall, China’s prospects for economic growth in 2009 appear to be well supported, with the stock market underpinned by strong liquidity in the short term.  However, the upside potential for the equity market could be capped by poor earnings visibility. 

While earnings downgrades have moderated, there is limited room for upgrades as stimulus measures take time to be translated into corporate earnings growth.  This leads us to believe that China’s equity market will remain within a trading range.  On the basis that the deterioration in the global economy stabilises by the end of 2009, China has the potential to achieve a sustainable recovery in 2010 and equity markets should discount this scenario towards the end of this year.
 
We continue to focus on stock selection in particular in sectors that we believe will benefit from the Chinese government’s fiscal stimulus package, including construction, cement and consumption, together with companies which are less sensitive to the economy. These include telecom equipment, IT services and alternative energy.  Given the large valuation gap between small/mid cap stocks versus large cap stocks, we are also carefully analysing opportunities in the small and mid cap sectors.
 
Possible risk factors ahead include the risk of a sharp deterioration in the global economy which would place significant pressure on Chinese exports and lead to worsening unemployment. Social instability would then become a greater concern for the Chinese government. Another risk is the effect of the aggressive expansion of both fiscal and credit policy, which could lead to asset price bubbles.

These could clearly have an adverse impact on long-term economic growth when, the government eventually decides to reverse such policy measures.