Market Views: Is it time to reduce China exposure?
China’s massive economy, the second-largest in the world, has long been attractive to global investors with its growing middle-class and urban populations.
Though access to Chinese markets is tightly controlled, the Qualified Foreign Institutional Investor (QFII) and the Renminbi Qualified Foreign Institutional Investor (RQFII) programmes and the more recent Bond Connect or Shanghai and Shenzhen Stock Connect mutual market access schemes, have enabled many foreign investors to get involved.
However, recent trade frictions and declining economic growth figures may give investors pause.
China has been caught up in a tit-for-tat implementation of tariffs with the US since March, with the latest action a 25% tariff on $34 billion of Chinese imports and another 10% tariff on an additional $200 billion in the works. In a television interview on July 20, US President Donald Trump even said he was willing to slap tariffs on all $505.5 billion-worth of Chinese imports.
Chinese economic growth is trending downwards as well, from 6.9% in 2017 to a forecast 6.6% in 2018 and expected 6.4% in 2019, according to the latest IMF World Economic Outlook report. That's backed by official Chinese data showing annual GDP growth in the second quarter at 6.7%, down from 6.8% in the first quarter -- the lowest quarterly showing since the third quarter of 2016.
We asked an Asian equities head, an Asia-Pacific investment specialist, and two Asian real estate investors whether these risk factors warranted a reduction in exposure to Chinese investments.
The following extracts have been edited for clarity and brevity.
Angelo Corbetta, head of Asia equity (London)
Amundi
Until we see some near-term resolution to negative drivers, such as the ongoing US-China trade dispute, we remain cautious and defensive on Chinese stocks.
The overall deteriorating growth outlook in the near term has clearly negatively impacted the earnings growth expectations for stock markets, which is why we remain defensive and prefer quality companies in domestic consumer and cyclical sectors.
However, investor interest should still remain high with the MSCI set to increase the weight of A-shares in its global indices again in September. The A-share premium remains in place, but is now close to its lowest levels since 2015. This may appear to be an attractive entry level in both absolute and relative terms versus H-shares on an historical basis, but it is also a reflection of current-very-depressed expectations for future growth and earnings.
There are three critical factors in this period that investors should be watching closely with regards to their Chinese assets exposure: the earnings momentum of the index (the next reporting season will be key); the index will remain under pressure due to concerns about China’s deleveraging process and tightening monetary conditions in US; and the ongoing US-China trade dispute – it could deteriorate before getting better.
In terms of exposure, the A-share asset class could be attractive on a medium-to-long term horizon, and we are waiting for potential entry points in the near future as well as closely monitoring risks associated with China’s deleveraging policy.
Within A-share sectors, consumer and software show expensive valuations while banks and property look cheap.
In our view, the long-term investor can no longer afford to bypass the Chinese markets for a diversified investment portfolio. Additionally with the MSCI changes, it will be favourable to consider China as a new investment asset class in its own right and not just as a part of emerging markets exposure.
A few developments on the horizon should help Chinese equity valuations remain attractive: The benchmark inclusion of equities and local bonds – likely to attract more capital inflows in the coming years; China is speeding up necessary reforms for its structural transition; the escalation of trade tensions looks [likely] to help push China to accelerate its reform agenda, especially further opening up of its financial sector to foreign investors to facilitate a structural transition towards a high-quality growth model.
Mark Wills, head of the investment solutions group, Asia-Pacific (Sydney)
State Street Global Advisors
We remain positive on the Chinese bond market, especially if the renminbi continues to depreciate as this would create a cheap entry point. Having stabilised its [foreign exchange] reserves the government is likely to want avoid another outflow, and attracting offshore buying into Chinese assets, particularly bonds, is a good way to achieve this. Some volatility in the renminbi/dollar [exchange rate] is to be expected given the political environment. [The State Administration of Foreign Exchange] has made comments affirming the stability and strength of the renminbi and have signalled they are aware of and are controlling the currency satisfactorily.
The need to keep liquidity in the Chinese economy means that while we think the tightening caused by the regulatory changes will continue, the authorities will keep the interbank rates low through the [reserve requirement ratio] remaining loose. This should be supportive of the Chinese bond market, making it an attractive place to deploy capital.
President Trump needs the [Republican Party] to not lose badly in the mid-term house elections on November 6. The tariff issue resonates with his supporter base. Our best guess is that China and the US will reach a rapprochement near the elections. Both countries have strong leaders who need to maintain a strong image in their domestic affairs, but keeping the Chinese economy on an even keel plus good US GDP and stock market returns motivate both leaders strongly.
We are constructive on China mid-to-longer term, but until the tariff argument is resolved volatility will remain elevated. Along with the government restructuring plan, this means the investing environment has been difficult. However the economy is in good condition and the financial markets should recover into the latter part of 2018.
Elysia Tse, head of Asia-Pacific research and strategy (Singapore)
Claire Tang, head of acquisitions for Greater China (Shanghai)
LaSalle Investment Management
Overall, the natural trajectory, whether there's a threat of a trade war or not, should be slower growth. China cannot be growing at 10% every year, so as the economy gets larger and larger, we should be seeing that. The deleveraging is really to de-risk some of the financial system, so with the de-risking in the financial system, that comes along with slower growth. But our big picture view is even if China doesn't give us 6.5% growth, and it is at 6%, it is still one of the highest growth rates by global standards, and that's from the second-largest economy in the world. So if you want to apply that 6% growth to the second-largest economy, the sheer increase of that economic value-add is still relatively large ...
The Chinese government is very serious and very determined to deleverage and reduce some of these financials risks in the system. Pacing the growth is probably one of their top priorities, so overall, in terms of our strategy, we want to make sure that we pick the deals that are a little bit more defensive to these types of systemic risks. In terms of the sectors that we focus on, the commercial investments that we're focused on, we're very much emphasising on value-add, so buying some of these [central business district]-type of properties that are underperforming and doing the value-add and doing the re-positioning and re-leasing.
The other is really logistics development. So we build warehouses around these tier-1 and tier-2 markets and then lease to these larger e-commerce companies or third-party logistics. So these are the main strategies that we're pursuing in China. Because the fundamentals for these two strategies, these two sectors, are very healthy, so it will be less impacted by the slowdown in the overall economic growth.
For more insights on investing in China, AsianInvestor is hosting its 5th China Global Investment Forum in Beijing on September 13. For more details, visit the website or contact us on +852 2122 5262.