News & Insights Erica Poon Werkun: Cyclical sectors are the key investment opportunity for 2020

Erica Poon Werkun: Cyclical sectors are the key investment opportunity for 2020
Which industry sectors are hidden gems that investors should pay more attention to? We sat down with Erica Poon Werkun, Head of Equity Research, Asia Pacific at Credit Suisse, to find out.

What are your expectations for Chinese equities over the next 12 months? 

EPW: Looking at investable Chinese equities and their relative valuations, we see the most interesting opportunities among equities listed in Hong Kong. Trading at one standard deviation below the long-term average, we believe the negative factors have largely been discounted by the Hong Kong market. Since June 1973, the market has only seen 60 months below this level. This represents a good buying signal irrespective of the economic cycle in a non-crisis mode. 

In contrast, A-shares have been trading at a premium of over 30% above H-shares’, thanks to several factors including the MSCI A-share inclusion. Investors may find the A-share market getting relatively more expensive and the H-share market looking interesting again. If the Chinese economy stabilizes and the growth of infrastructure investment recovers from the current weak level, the risk-reward profile of cyclical stocks will look attractive, particularly those Hong Kong-listed ones that are not as affected by the local situation.

Chinese technology stock valuations have been impacted by US-China trade sentiment. Does the sector still present an opportunity for investors and why?

EPW: US-China trade sentiment has had a major negative impact on Chinese technology stock valuations. However, it has also created opportunities: first, the acceleration of 5G migration; and second, domestic substitution in China. In response to the trade discussions, China is accelerating its 5G rollout, which creates significant opportunities for its technology ecosystem. We see stronger demand for 5G smartphones in 2020 onwards compared to the demand recorded for 4G smartphones following the initial 4G rollout. 

On the other hand, the trend of domestic substitution in semiconductors and key components is speeding up. We believe that China will continue to strengthen its semiconductor supply chain with a stronger preference to adopt local suppliers. 

The acceleration of 5G migration and domestic substitution in China are the two longer-term themes that will play out over several years. We may see the beginning of a sector re-rating in 2020.

Smartphone and 4G penetration as at December 2018
Source: Company data, Credit Suisse estimates

Which industry sectors would you consider as hidden gems that investors are not paying enough attention to and why?

EPW: We see cyclical sectors as the key 2020 opportunity that is not getting investors' full attention. These sectors include autos, industrials, materials, banks, diversified financials and real estate. They are all heavily linked to the economic cycle, particularly investment activities. We have seen continued underperformance in these sectors, which indicates that the market has low expectations for Chinese cyclical growth and a lack of confidence in the government’s ability to stimulate it. However, cyclical stocks could stage a very strong rebound at the early stage of a business cycle recovery. In the past ten years, that has been usually associated with a pick-up in industrial activities and M1 growth. Looking ahead, if the economy stabilizes with a more apparent rebound in M1 and growth of industrial activity, the risk-reward profile of these cyclical stocks will look attractive.