In what is proving a tricky issue for wealth managers, events do not point to a clear path for China's economy and some investors cannot shrug off worries about what they see as unjustified price action.

China throws up a lot of contrasting pictures at the moment. There are stories of surging volumes on the country’s stock market link with Hong Kong; the central bank keeps pulling the monetary trigger to boost growth, while in some corners there are mutterings that this red-hot economy (at least when compared with that of other regions) is decelerating at such a pace that a “hard landing” is all but inevitable.

As an example of the uncertainties out there, the latest Bank of America Merrill Lynch poll of global fund managers, when it asked what investors consider to be the biggest “tail risk" (i.e. an extreme event), found that a risk of a Chinese debt default ranked only second to general geopolitical risks. Separately, the People's Bank of China, the central bank, said recently that it would cut the rate on a one-year loan by commercial banks by 0.25 percentage point to 5.10 per cent. The interest rate paid on a one-year deposit was lowered by 0.25 point to 2.25 per cent. Interest rates were also cut on 22 November and 1 March.

Over at ETF Securities, a research analyst, Nitesh Shah, accepts that there are causes for some concern but argues that the Asian giant – the world’s second largest economy – is highly attractive given the government’s commitment to structural reforms. Its markets are relatively cheap, even after a hefty rise this year (the MSCI China A International shows total year-to-date returns of 32.7 per cent; last year, it was a sizzling 129 per cent, in dollar terms).

Chinese equities are, Shah says, pretty decent value on relative basis. Last year, their price/earnings ratios were 12 times earnings; that has now risen to 23 times, but the figure is within a one-year standard deviation mark as seen by performance over the past five years.

Shah reckons there could be more uplift to come in China because Morgan Stanley Capital International – MSCI – is getting closer to allowing the Chinese mainland’s A-Share market into its MSCI Emerging Markets Index. And once a country is in a big global index such as this, it generates its own positive momentum because the shares become eligible for inclusion in a broader range of portfolios.

There are also, Shah said, moves by the International Monetary Fund to consider allowing the renminbi to be in the basket of currencies for Special Drawing Rights, a move that will bolster the currency’s status as a serious global currency and chip away at the supremacy of the dollar.

“China’s central bank wants full capital account convertibility by the end of year i.e. the freedom to convert overseas financial assets into domestic assets at market determined rates. Broadly speaking it will mean that companies and households can buy overseas assets such as equities, bonds and property as well as the free repatriation of proceeds by foreign investors,” he said.

“Some people think the [rapid growth] story has run out and that past growth cannot be extrapolated much further and that there may be a reversal,” Shah continued.

Set against the doomsters is the point, he said, that China has been taking measures to open up its capital/financial markets, such as by developing municipal/local government bond markets to make financing more transparent and bring the “shadow banking” system that had been previously associated with it into the open. “It has all been mostly viewed positively by international investors,” he said.

One of the paradoxes of some softness in property markets is that it has encouraged investors who previously looked to real estate as a key asset class to put money into equities instead, he said. There is as yet limited ability among private investors to short mainland China shares or hedge downside exposure. The market remains very “DIY”; there is a gradual development of a funds market taking place, which will bring the investment market into a more structured forum, he said.

There are troubles ahead
It is sometimes said that if there was a total consensus on market valuations then there would be no need for them, and if so, there remains plenty of disagreement over where China is headed. For example, Andrew Herberts, head of private investment management (UK) at Thomas Miller Investment, talked about the recent bull run in Chinese stocks and the fact that the Shenzhen composite has traded on more than 50 times earnings.

“China’s stock market resemblance to that of Western markets in 1999 is partly the result of the vast growth in Chinese domestic investors, who seem to be fuelling a speculative bubble in Chinese equities. Inexperienced individual investors are investing in companies which they do not understand but are still making money. The situation is being compounded by the rise in amounts of risky retail margin trading, whereby investors borrow money from dealers rather than invest their own capital,” Herberts said in a note.

“Stock market bubbles like [that of] China’s have usually proven to be unsustainable, but can endure for surprisingly long periods of time. This market may run for another few years before the bubble bursts, especially if the country’s growth regains momentum, helping to justify current valuations. It is likely that investors in China will be heavily brought back down to earth at some point but may well not get burnt just yet. Investors should consider any exposure they have to the area and keep in mind that when the bubble does burst, it will be widespread and not contained only within China,” he added.

Debt disease and cure
Andy Rothman, an investment strategist for Matthews Asia, a US-headquartered firm that focuses on Asian investment, said debt levels in China have rattled some investors, but said some fears are overblown.

“There is no question that debt levels in China rose sharply after the global financial crisis that began in 2008. A recent study by the McKinsey Global Institute says that from 2007 to 2014, China’s total debt, including debt of the financial sector, nearly quadrupled, rising from $7.4 trillion to $28.2 trillion, or from 158 per cent of GDP to 282 per cent,” Rothman said in a note.

Another new report, he said, written by economists at the Hong Kong Monetary Authority’s think tank, said that the rise in indebtedness “has been partly related to a big stimulus package launched in 2008 to 2009. Unlike the deficit-financed stimulus packages in the West, China’s big stimulus package was funded mainly by bank credit”.

The treatment and consequences of easing China’s debt position may not be as severe as some expect and dramatic credit tightening is very unlikely, said Rothman, arguing that debt is concentrated among state-owned firms, while the private firms that generate most of China’s new jobs and investment have already deleveraged their balance sheets. The biggest risk is the high level of debt among real estate developers, he added.

If there is one clear prediction it is that the path of China’s markets and economy are unlikely to be smooth. So far, at least, the force appears to be with those arguing that China faces formidable, but not insuperable, challenges in shifting its economy.