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Falling Markets, Angst Over China: Wealth Managers' Thoughts
Tom Burroughes
22 January 2016
There is a familiar Chinese curse – “May you live in interesting times”. The New Year has become more interesting than many wealth managers and their clients will have wanted. Markets are in the red. China’s economic deceleration – while not necessarily a shock to anyone paying close attention – is unnerving markets; oil prices have slid and many major equity indices have fallen into bear market territory. Here are some reactions. Andrew Swan, head of Asian equities for the fundamental equity division of BlackRock’s Alpha Strategies Group. He writes about China:
We remain constructive on H-shares where we see better relative value. We prefer accessing Chinese stocks via the offshore markets and only have very limited exposure to the A-share market (less than 0.6 per cent in any of our funds). We stay focused on selecting stock specific exposure in both new and old economy stocks that can benefit from China’s structural reforms, but are cautious on adding exposure in what is a very volatile market.
In the offshore equity market, we feel that the pessimism is well-priced in in the Hong Kong listed stocks. Higher volatility is expected in the near term, but with better structural improvements already put in place over the last couple of years (and further improvements may be on the way), we believe that if Chinese regulators successfully achieve a soft landing, we may see a better environment for H-shares than we have had over the past five years.
Market sentiment has soured dramatically towards the A-share market, even though the CSRC Korea’s are set at 8, 15, and 20 per cent. Some adjustments are required ahead of it being reinstated.
John Vail, chief global strategist, Nikko Asset Management. He writes about Japan:
In any market, corporate profits should be the main driver of equity prices as long as valuations are fair, and on this front, as commodity prices remain low and corporate governance remains strong, Japan's earnings and earnings expectations should outperform those in the West. Since equity valuations are also more attractive than in the West, these two factors strongly suggest that Japanese equities should outperform global equities in the next six months. Japan does have high operational gearing due to lower profit margins than the West, so if there is a global recession, the equity outlook versus global markets is not as strong, but still relatively firm, in our view.
Fortunately, Japan has relatively minor commodity-producing exposure, so its corporate profits have performed much better than European or American corporate profits during the commodity bust of the last eighteen months, as mining and energy multinationals comprised a significant portion of corporate profits in the West. Meanwhile, the effects of low energy prices have pummelled energy-based economic zones in the US, as have low agriculture prices in its farm-belt. Similarly, parts of Europe have been hurt by lower energy prices and the region has been hit by the effect of mutual economic sanctions with Russia.
Corporate profits in Japan have also benefited from lower commodity input costs, and perhaps as much as any country, Japanese consumers have benefited from lower import prices of such (although partly offset by a weaker yen). On the converse, recent media reports and analyst commentaries are suggesting the ECB's QE programme has failed to lift profits, although it seems clear profits would have been much worse without QE and that much of the profit problem was commodity price-related and, thus, out of the ECB's control.
Importantly, yet completely separate from QE or other global fundamental factors, Japan has structurally improved its corporate governance. As my earlier writings have indicated, this improvement began ten years ago, but only became widely apparent in the last few years, and was augmented even further by Abenomics (along with the beneficial political stability that he has brought). The effect on corporate profits has been very strong, and expectations by the market for continued profit maximisation has also boosted intermediate-term earnings estimates, which are extremely important for equity valuations. As corporate governance improvement has become mainstream, we expect this trend to continue developing this year, as there is yet much more to accomplish.
Jan Dehn, head of research at Ashmore. He writes on China and the US:
Banks and sections of the media continue to bleat about China’s role in the global equity market sell-off. From a fundamental perspective, this fascination with China as a driver of global weakness borders on the surreal. After all, few investors in the developed markets have any exposure in China at all, while they are loaded up on US stocks. There is a similarly negative entrenched view about China’s currency, that China needs a materially weaker renminbi.
Clearly, the fundamentals do not justify such pessimism. China is running a current account surplus of $60 billion per month, has $3.3 trillion of reserves and real rates that are far higher than in developed markets. Most foreign exchange mismatches on corporate balance sheets in China were neutralised last year. Chinese growth is far stronger than in most developed economies and inflation is roughly the same. Lastly, the property market is very healthy with sales up 63 per cent year-on-year in 2015 in "tier one" cities and 34 per cent higher year-on-year in "tier two" cities. Only two developers out of 38 had negative sales in 2015 and 27 met or exceeded sales targets. Loans to the real economy rose strongly to RMB1820 billion in December from RMB1018 billion in November.
As China accelerates its liberalisation efforts and institutional participation becomes more important in all China’s markets then the current inefficiencies will gradually wane. The real risk facing China is excessive currency appreciation. QE will eventually trigger inflation and currency weakness in the countries pursuing such policies. When this happens, the renminbi will come under constant pressure to appreciate against the QE currencies. It is important that investors and the Chinese authorities alike continue to keep their eyes firmly on this particular risk. This is why China must continue to reform, even in the face of short-term speculative pressures. China is travelling in the right direction and those investors that buy a business ticket for the whole journey are more likely to end up richly rewarded than those clinging to the handrails for a short ride.
US
A lot of global capital is now tied up in long US dollar and long US stock market positions. These positions have been put on in anticipation of stronger US growth and Fed hikes; but if, in response to a weakening economy, the Fed must reverse its December hike and perhaps even go to negative rates instead of hiking four times in 2016 then the outlook for the US dollar is not good. It is, after all, the only remaining policy instrument available to US authorities. New York Fed chairman William Dudley said last week that the Fed would consider negative rates if the economy weakened.
The US needs more than monetary stimulus. It needs supply-side reforms, higher productivity, less debt and external rebalancing. Sadly only a weaker dollar looks remotely possible, given the Administration’s complete lame duck status vis-à-vis Congress. The silver lining is that the US government no longer runs 10 per cent of GDP fiscal deficits, so foreign demand is no longer essential to financing the deficit, at least as long as rates remain very low. In turn, this means that the dollar can be weakened without affecting refinancing operations.