The risk of holding Chinese assets has risen since the country moved against for-profit, after-school education firms and went after a number of other sectors, the Swiss firm said.
Pictet Asset Management, part of Swiss bank Pictet, has cut exposure to Chinese equities following Beijing’s regulatory crackdown on the for-profit education system in the country and moves against other sectors, policies that have pushed up risks to holding assets in the world’s second-largest economy.
The firm has also turned bullish on European equities, citing improving vaccine rollouts, while it is underweight US stocks, saying that they are expensively priced.
“We feel justified in taking profits in Chinese bonds, which have performed strongly year-to-date,” Luca Paolini, chief strategist, Pictet Asset Management, said.
In a note updating clients on Pictet’s asset allocation policy, Paolini said the Chinese government’s surprise ban on for-profit after-school tutoring, essentially shutting down the circa $100 billion “edtech” sector, has raised concerns about an intensification of Beijing's regulatory crackdowns. The latest intervention comes on the heels of cybersecurity investigations of the ride hailing app DiDi and other e-commerce companies, increased scrutiny of overseas IPOs and the imposition of fines and restrictions on some of China's largest e-commerce firms. (This publication has also written about the issues here and here.)
"However, we don’t think a full-scale withdrawal from Chinese stocks is warranted. The PBOC recently lowered reserve requirements for domestic banks and hinted at a potential shift in favour of looser monetary policy to lower the cost of servicing debt and support growth, which should underpin risky assets in the medium term."
Beijing has also restricted the use of the variable interest entities structure – holding companies based in tax haven jurisdictions, designed to allow foreign investors to invest in key sectors such as tech without giving them any operational control.
The moves by China, which wrongfooted investors, hammered equities more than a week ago, raising questions about whether the Chinese authorities are aware, or care, about how such policy moves might hit investors. Ironically, the country has continued to push various schemes such as its Hong Kong mainlaind stock market links, various foreign investor quota regimes and capital programmes to bring capital into the country.
Taking a positive view
"A positive reading of such developments is that they are a belated response to innovation and the breakneck growth of industries that flourished in the absence of a regulatory framework. Even though such moves would in effect add a permanent 'risk premium' to Chinese stocks and bonds, they should not fundamentally change China’s growth model or the broader investment case for the country's financial assets,” Paolini said.
Pictet AM said it is keeping to a neutral allocation across equities, bonds and cash; it favours assets that benefit from stronger economic potential, such as European stocks.
Turning to the US, Paolini said US equities look expensive, with a price-to-earnings ratio of 21.5 times based on 12-month forward earnings. “[This] can only be sustained if trend growth is unchanged, profit margins are stable at high levels and bond yields stay low. So far, the recovery in US earnings has been in line with GDP, and we think further upside to this year’s corporate profit growth is unlikely in the absence of an upward revision to US GDP growth forecasts,” he said.
More positively, Paolini said that European equities look a more attractive prospect because a “smooth” vaccine rollout allows governments to lift lockdowns.
“The region is now taking the lead in the recovery from the COVID crisis from the US, with business activity across the region expanding at its fastest rate in 21 years and mobility indicators having already returned to pre-COVID levels,” he said. “For these reasons, we upgrade the eurozone to overweight.”
Pictet is also turning overweight of its home market’s equities. “We also upgrade Swiss equities to overweight. Swiss equity markets are home to many quality stocks, which tend to perform well during the middle phase of a bull market cycle,” Paolini said.
The firm’s investment models show a “buy” signal for UK stocks. “It is a market with a high dividend yield of 4.2 per cent, more than double the global average, and is also attractively valued on other valuation metrics,” he said.
Pictet is staying neutral on Japan, saying that economic data is “disappointing and the pace of vaccinations is slower than other major economies.”
The firm has taken profits on US Treasuries after a strong rally in the market, and the Swiss firm has cut its position to neutral from underweight. Pictet has taken a similar move on Chinese government debt, cutting its exposure slightly, although remaining an overweight position.