Asia-based investors have voiced doubts about Chinese economic growth for the second half of the year, with some cutting equity positions despite MSCI’s decision this week to partially include A-shares in its emerging-market indexes and the improving access to mainland stocks generally.
“We recently turned neutral on China and recommend investors book profit in the market and wait for a better entry opportunity at lower levels,” said John Woods, Asia-Pacific chief investment officer for private banking and wealth management at Credit Suisse.
Following a “relentless rally” in the MSCI China index of 24% between January 1 and mid-June, he told AsianInvestor, the market is due a consolidation.
Tightening liquidity conditions – aimed mainly at reining in excessive financial leverage and shadow-banking activities – and slowing economic momentum are raising investor concerns about a steeper slowdown, he noted.
Asian institutions are certainly proving cautious on China. Japan’s Pension Fund Association, Hong Kong’s FWD Insurance and Thailand’s Government Pension Fund all told Asianinvestor last week that their mainland exposure was small and they had no plans to increase it any time soon. GPF has just 1.22% of its $22.4 billion in mainland assets, evenly split between stocks and bonds.
Woods added that the impact of MSCI’s decision to include 222 A shares in its influential EM indexes was likely to be muted and gradual. He said onshore mainland stocks would make up about 37bp and 74bp of the MSCI EM index by May 2018 and August 2018, respectively.
The passive flow into A shares should be minimal as a result, he noted, and investors may sell Hong Kong-listed H-shares to fund such purchases.
The full inclusion of A-shares could take at least nine years, going by the experience of South Korea and Taiwan, he added. Both countries experienced a phased introduction, whereby the weight of stocks in the MSCI EM indexes increased gradually with greater liberalisation.
Moreover, if headline Chinese economic data were to soften further in the coming months, this could dampen investor enthusiasm, said Woods, especially among fund managers who were chasing the rally to close their underweight position.
Tech sell-off tipped
A China market pullback would probably be led by technology names, which comprise 30% of the MSCI China Index, he noted. The 37% return in tech stocks in the year to mid-June was in part a measure of receding market enthusiasm toward the ‘Trump trade’, which had driven a rotation into structural growth stories.
Following Donald Trump’s election as US president in November, his promise of tax cuts and infrastructure spending prompted investors to talk of a ‘reflation trade’. This referred to expectations of inflation driven by fiscal stimulus in developed countries based on expanding economies. Chinese firms were among the beneficiaries of this sentiment.
Such plays look less appealing now, said Woods. Following a mixed first-quarter earnings season and high historical valuations for the Nasdaq, he added, the tech sector looks susceptible to profit booking.
Moreover, Aaron Costello, Beijing-based managing director at investment consultancy Cambridge Associates, agreed that monetary tightening by the Chinese central bank to rein in leverage would restrict growth and impact domestic equities.
As a result, the firm is bearish on investments in Asia that rely on economic growth to drive returns, he said. “In China specifically, we view most assets as expensive, whether it be A shares, real estate or private equity.”
However, some investors were more sanguine.
Frank Lee, Hong Kong-based acting CIO for North Asia at DBS Bank, said the slowdown would be temporary and that Chinese equities remained good value. Hong Kong/China is the firm’s key overweight market this year, he said, and indeed the only Asian overweight in his portfolio besides the Philippines, entering the third quarter of 2017.
Nathan Chow, Hong Kong-based equity analyst at DBS, said in a research note this week that China’s real economy was set to slow in the second half, unless the course of tightening were reversed. But he pointed to the country’s strong fundamentals, including imports and exports rising for the past 14 months and PMI numbers climbing for the past 18 months.
While technical signals suggest Chinese stocks are overbought, they should resume their uptrend after some consolidation, Chow said, citing Beijing’s commitment to sustained domestic spending and the growing services sector.
Cambridge’s Costello conceded that certain sectors and assets in China were still attractive, such as private credit and special situations funds, as they may benefit from market stress.
Meanwhile, healthcare may not be cheap or a value play, he noted, but nor is it reliant on economic growth. “We think the structural story is something investors need exposure to, and private investments seem more attractive than public equities in the healthcare space in China.”