Investment Committee: China woes spread, but opportunities remain

Laura Suter

Laura Suter, editor of FundStrategy

Just as the dust settled on the Greece saga, the quiet summer was interrupted by the shocks coming out of China.

First, the world watched as China markets plummeted, with equities crashing. The Government intervened, propping up the markets, which prompted non-domestic investors to grow concerned about the level of any future interventions. Second came the shock currency devaluations from the People’s Bank of China. The successive drops in the yuan took markets by surprise again, and led to fears about a continued devaluation of the currency.

But the real concern is that China is not an isolated country, acting increasingly erratically alone. Unlike the troubles in Greece, which could be dismissed as a tiny piece of the world economy, China accounts for 17 per cent of world GDP on a purchasing power parity basis. And that’s too big to ignore.

However, many think the shocks can’t go too much further. While a devaluation of the renminbi will help Chinese exports, a continued devaluation would do more harm than good, say experts. Instead, the PBoC is just trying to dial back the appreciation the currency has seen so far this year, largely due to the effects of the strong dollar.   

This hasn’t stopped China’s moves having a knock-on effect to other emerging markets and Asian currencies. This in turn has led investors and fund managers to be skittish on emerging markets generally.

A recent Bank of American Merrill Lynch survey of fund managers found emerging markets was the region they wanted to be most underweight – although continuing fears over the impact of a strong dollar and underperformance in these markets have undoubtedly compounded the group’s problems.

Those able to fully research the market might find some hidden gems.

 

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James Calder, head of research at City Asset Management.

Retail investors are understandably wary about China. On the one hand, investors are wooed by stellar GDP growth rates and positive media speculation on the rise of this once sleeping giant. On the other hand, these expectations are dampened by the reality of an exceptionally volatile equity market.

So, where do we stand? There is, undoubtedly, a strong economic growth story; even if GDP rates fall they are still in excess of what the developed markets could hope to achieve and their absolute growth is still higher than it was pre-crisis, due to compounding effects. Taking a single country approach, one can choose a skilled stock picker but should be cognisant of where the exposure is taken. This may be local or foreign; the Shanghai A-share market, or through the backdoor in the form of the Hong Kong H-share market. Both markets have pros and cons, but lately some investors may argue that the A-share market is increasingly open to government interference or abuse.

Until we take a strongly positive single country view, which we may do over the medium term, we favour buying generalist global emerging market and south-east Asia managers who can hold Chinese stocks as part of a regionally diversified portfolio. While China faces significant challenges over the short term, we are yet to firmly believe in a hard landing for this market.

Jason Stather Lodge

Jason Stather-Lodge, CEO, OCM Wealth Management

China’s balance of trade surplus decreased by almost 14 per cent in July versus its forecasted figure – $43bn versus $49bn – mirroring a consecutive month of under-achieving its target.

Manufacturing is China’s core engine for growth and in July the country saw a sharp fall in exports of -8.3 per cent in comparison to July last year. This is significant and will have a direct impact on the country’s growth, and ultimately consumer affluence in the region. This indirectly affects the revenue of companies who are reliant on consumers in the region.

The result? Global stock market instability. The People’s Bank of China responded by devaluing the currency by as much as 4 per cent, causing significantly higher levels of volatility in emerging markets and stocks exposed to the area, where most assets declined in value as a result of the fallout.

The world is looking very closely at the new consumer in the emerging market regions, including China and India, to drive growth in large and mega-cap companies.

A number of risks could transpire to end the global equity bull market and those risks emanate from China, given the lower growth expectation in the region. This could have a knock-on effect on mega-cap forward earnings expectations resulting in an equity pullback. Global trade is not as strong as it could be, and many countries are facing mounting debt pressures so at the same time investors need to be on the lookout for the possibility of a sharp rise in bond yields.

John Husselbee, Liontrust

John Husselbee, head of multi asset at Liontrust.

While we are not holders of any funds that are wholly invested in China, we know we have to take more than a keen interest. It is fair to say that recent events on the mainland have been pretty spectacular in terms of the rollercoaster ride in their stockmarket, the domestic A-share index in particular.

While large falls are bound to grab the headlines, they are usually preceded by large gains, as is the case here with returns over the past year exceeding 100 per cent. General consensus seems to be that the effect on the economy in the long run is not significant, as the bias moves away from an external-focused economy based upon manufacturing.

The recent yuan devaluation seems to be in counter to this policy; devaluation is obviously positive for exporters but negative for importers. China is a maturing economy and greater flexibility where the market decides the price should be welcomed by investors. However, stockmarket intervention by the Chinese authorities is a step backwards and sends conflicting messages.

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Lee Robertson, chief executive of Investment Quorum

We are experiencing a real ‘boom and bust’ scenario surrounding the Chinese stockmarket and, while it should have a limited immediate macro impact, fears are growing that a crisis is coming.

The Chinese government and the central bank have reacted quickly to attempt to stabilise the situation and it has been reported that the banks have provided some $200bn of funding to prop up the market via the China Securities Finance Corporation, however, figures surrounding the amount of bad debts created by the fall in the market can only be estimated, even after the falls on the Shanghai Composite Index it is still up for the year.

The Chinese have carried out the biggest devaluation of their currency in two decades taking fairly decisive action to support their slowing economy, marking an escalation of international ‘currency wars’, surprising markets and risking a clash with Washington. The 2 per cent downward move by the People’s Bank of China was its biggest one-day change since 1994 and since China abandoned its tight currency peg for a managed float in 1995. This action was a shock. Conversely, companies and investors will need to get used to this volatility as there are likely to be further repercussions.

We have seen a weakening of stockmarkets around the world, and in terms of individual sectors, many stock prices of European luxury goods companies were weak as the devaluation makes them less competitive against the Chinese companies. Going forward we still believe in the China growth story over the long term, given that it is the world’s second biggest economy. Even with lower growth rates than we have become used to it should continue to add value to investors. However, over the short term we are going to continue to see some real volatility.

 

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Mike Deverell, partner and investment manager at Equilibrium Asset Management

They used to say, “when the US sneezes the world catches a cold”. Now, that’s true of China too. For example, poor economic data from China and its reduced infrastructure investment has driven commodity prices lower. This means the FTSE 100 has dropped significantly due to its high proportion of energy and resource stocks. This has also driven down inflation, meaning rate increases might be deferred and bond prices have therefore rallied.

But what about investing in China itself? It is important to differentiate between shares on the Shanghai or Shenzhen markets (A-shares) to those listed in Hong Kong (H-shares). A-shares have not been reacting to fundamentals in the way a market should. Their price was driven up by government intervention and since they have started falling the authorities have tried all sorts of tricks to halt the slide. This is not an investable market.

However, Hong Kong is a properly regulated market and stocks are principally owned by international institutions. Chinese H-shares don’t look bad value on many metrics such as price-to-earnings or price-to-book. Their price already reflects many of the economic risks and as such it might not be a bad time to invest.  

Ben Stoves

Ben Stoves, investment analysis at Rowan Dartington 

Chinese markets are having a year to remember. If we continue to see the same level of government intervention and central bank action in the remainder of the year, then increased market volatility is inevitable.

We know that it’s an economy in transition and whether we should still refer to China as an emerging market, having been labelled as such, is already open for debate. It is not going to be able to sustain the high levels of economic growth that investors have become accustomed to, although this is not necessarily a bad thing.

The implications for global markets, however, are substantial. A sizable chunk of most equity markets, both emerging and developed, is extremely reliant upon Chinese demand, so how these industries adapt to an evolving Chinese economy could define how the market is shaped in years to come.

Longer-term, the bull case still stands. China could well become the world’s largest economy and with its growing middle class and their aspirations, the outlook is ultimately positive. In the meantime though, it’s in for a very rocky period that we expect to continue for some time yet.

Independent view:

Chillingworth Julian Rathbones

Julian Chillingworth, chief investment officer at Rathbone Unit Trust Management

Despite the panic it conjured, the renminbi’s most significant fall in 20 years is unlikely to have dramatic consequences on global investments.

Deflationary pressures in the West will edge up, paid for by increased inflation in Asia, because of the effects of cheaper imports. Correspondingly, some companies exporting to China have already experienced share price falls because of eroded competitiveness. Korean suppliers, in particular, will be squeezed as they sell similar products in similar markets; it is likely that the Korean won will soon be competitively devalued as well.

The Chinese government argues it is opening up to market forces, but the timing might be deemed coincidental. The renminbi cut follows poorer growth estimates and a precipitous fall in the mainland stockmarket from its peak in early June. Devaluing the renminbi would give Chinese exporters a boost, however, the currency would need to fall much further to be useful.

A concerted devaluation would drag down other Asian currencies and put the spectre of another eastern currency crisis in the frame. Unlike 1997, the pain would be felt by dollar-leveraged emerging market corporations, and their equity and bondholders, as opposed to the governments, which have largely learned their lessons. The fall may reduce the chance of a ‘hard landing’ for the Chinese debt bubble; the country’s corporate and household loans are now about 175 per cent of GDP.

That tremendous level of borrowing in the economy is limiting the effectiveness of Chinese attempts to use conventional tools to loosen monetary policy. For its part, the Bank of England may consider holding off even longer on any rate rise as it remains sensitive to the fragile recovery of UK manufacturers: the renminbi accounts for about 9 per cent of sterling’s trade-weighted basket, and any devaluation could exacerbate the pound’s rise.