Of all the consensus views that are pervasive in the market, negative opinions with respect to China’s economy and market are probably some of the most entrenched. Capital is allegedly bleeding out of the nation, draining currency reserves and dragging the renminbi down as it does. But while there have been outflows and the currency has readjusted, the effects are often overblown.
The headlines also tend to overlook the progress that is being made, instead going for the attention-grabbing stories that don’t convey the real story. But for those that really understand China’s economy, this negative picture isn’t necessarily a bad thing. In fact, from an investor perspective, it can present investment opportunities, not just with respect to China itself but for emerging markets more broadly.
A key factor in our thinking is that many of the markets concerns have simply failed to materialise. There has been no “hard landing”, commodities haven’t crashed, and nor has the Chinese economy for that matter. In fact, there have been a number of positive developments and China’s markets appear relatively calm. This isn’t to say we don’t acknowledge the risks. We do, but we don’t envisage the same degree of risk as the consensus over the next 12 months.
Investors' views on China have of course been tainted by the previous episode of currency depreciation, capital outflows and the 2015 growth slowdown. This coincided with the commodity market correction, a large part of which was driven by technology changes in the United States and a reduction in its demand for oil, rather than any major transition in demand from China. Nevertheless, China’s economy has had to transition as well and today it finds itself less dependent on exports and more focused on domestic demand, with broader and better quality drivers of growth, albeit growth has fallen somewhat. We appreciate this is going to be a long-term transition, one that the market has perhaps struggled to digest so far given policy has historically been more focused on achieving unsustainable rates of growth, rather than trying to rein in the excesses.
There will be a time in the future when China’s economy opens up further to the global markets, it will then have to endure more influence from external market and thus having less control over all aspects of the economy. However, as of now, controls are still firmly in place and they can react quickly when they think that intervention is needed. For example, when there was huge depreciation pressure on the Renminbi (RMB) in 2016, officials implemented capital controls quickly, and banks and onshore investors were not allowed to move money outside of China to maintain currency stability.
Coming into the start of the year we saw opportunities to be long the Chinese yuan as expectations of depreciation were at their highest and currency volatility began to decline to about 3%. This is less than half that of many G10 currencies and at least a third of a number of emerging market currencies. The tightening in policy has also increased the attractiveness of domestic bonds, while beginning to address concerns over excessive credit growth. Ten-year government bonds yields of around 3.7% compare very favourably to their developed market counterparts and, while Chinese bonds are only starting to enter global benchmarks, they are still under-owned.
Third-quarter growth at 6.8% met analyst expectations but we wouldn’t read too much into this. Ultimately, we appreciate there is still a need to address excessive credit growth, particularly while property prices are still seeing notable rates of growth. This may temper growth in the longer term. Nevertheless, from an investment perspective the time to worry about China is typically when it has fallen off investors’ radars. And that certainly isn't the case yet.
The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested.
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