23 January 2012 marks the beginning of the Year of the Dragon in the Chinese lunar calendar. In Chinese astrology, the dragon is the king of all animals, a symbol of power, strength and good luck, which could bode well for investors in the China equity market over the coming 12 months.

As we look to the year ahead, our fundamental outlook on Chinese equities remains positive. In spite of a modest rally in Chinese equities through the autumn, share price valuations remain at the lower end of historical ranges in both Hong Kong and the domestic A-Share market, and we believe this represents an attractive opportunity for investors to participate in a multi-year growth story at a low entry level.

The pessimism that gripped markets for much of 2011 was based largely on concerns related to the eurozone debt crisis and renewed doubts over the recovery of mature economies such as the US. Conditions in Europe remain challenging, although the risks of a systemic problem seem to be moderating. Conditions in the US, however, have shown signs of improvement, and we could well see investor sentiment begin to turn around in the coming weeks and months as the risk of a global recession – which many investors feared – appears to recede.

The most recent figures show the Chinese economy itself continues to expand at an annual rate of 8.9 per cent, on track, in our view, for a 'soft landing'. It is worth highlighting, in the welter of press coverage on this, that this is still a multiple of the economic growth available in most other areas of the world.

As one of the earliest developing economies to raise short-term rates to take some of the heat out of the economy, the Chinese authorities now have scope to reverse this process to bring additional stimulus. We recently saw a cut of 50 basis points in the bank reserve requirements by the People’s Bank of China, the first such reduction since December 2008, and a move that has the potential to encourage banks to lend additional money. In our view, the recent announcement is supportive of economic growth and evidence that the Chinese Central Bank feels sufficiently comfortable with the outlook for inflation that it can begin to loosen China’s monetary policy.

We believe that inflation and policy risk has started to moderate, while the government’s pro-growth policies should, in our view, make smaller and medium-sized companies deserving of renewed interest this year, particularly the latter. If inflationary pressures continue to ease as we are expecting and confidence begins to return to the Chinese market, we believe that earnings growth will once again become the principal driver of equities. In this environment, we expect our commitment to companies with good growth prospects and strong balance sheets, well positioned to benefit from rising consumer and infrastructure spending, to reward investors in our China equity portfolios.

As we head into 2012, our strategy will focus on companies where we have high conviction in their ability to deliver sustainable earnings growth in the coming years, especially companies with strong balance sheets and robust cashflows. We will selectively add to positions in these companies where we believe value has emerged during the recent market weakness.

Kung Hei Fat Choy! May you prosper this Chinese New Year.

By Agnes Deng, head of Hong Kong China equity at Baring Asset Management, Hong Kong