China’s economy grew more than expected in the third quarter, potentially creating a floor for the country’s beleaguered stocks. But investor wariness about geopolitics—on top of concerns about China’s economic trajectory—could hinder a sustainable market recovery.
China’s third-quarter data reinforced anecdotal signs the economy is beginning to stabilize. The economy expanded 4.9% from a year earlier, beating expectations as retail sales improved and industrial production picked up. The property market, however, continued to struggle.
While the headline GDP number appeared positive overall and retail sales and industrial production data improved, there’s effectively a Catch-22, according to TS Lombard economists Rory Green and Freya Beamish. They say the better-than-expected data could keep Beijing from bolstering its stimulus efforts, but at the same time, the numbers aren’t strong enough to indicate the economy is rapidly gaining momentum.
The data could help stem further losses in Chinese stocks in the near-term, as the
iShares MSCI China
exchange-traded fund (MCHI) has fallen 8.3% so far this year. However, for an actual stock market upturn, Beijing will need to deliver stronger stimulus, and economic activity will have to show continued momentum on multiple fronts, analysts say.
But investors remain wary of China’s geopolitical risks—particularly increasing tensions with the U.S. as it restricts China’s access to advanced technologies and both countries’ increased push to become less reliant on the other. Such risks could continue to overshadow improvements in the economic environment and, in turn, prevent investors from returning broadly to Chinese assets.
A recent survey of global investors by
JPMorgan Chase
(JPM) found that geopolitics topped the list of investors’ concerns about China, followed by worries that Xi Jinping will continue to centralize power and increase intervention in the private sector. Such concerns were reflected in their holdings, which show reduced exposure to the world’s second-largest economy.
Of the investors surveyed, 38% said they were underweight China, meaning they hold less in the country than the amount allocated in their benchmark indexes. Another third said they aren’t currently invested in China.
Only 5% of the investors surveyed had a higher allocation than their portfolios’ benchmarks. Even more telling: 40% of those that were underweight China said they were looking to reduce their allocations further.
For any market recovery to be sustainable, investors will need to decide how to invest in China while shielding themselves from the geopolitical risks. One of the biggest is the continued tightening of U.S. restrictions on exports to China of certain advanced chips for artificial intelligence. The U.S. Bureau of Industry and Security released export restrictions last October, and further tightened those curbs this week.
Among those targeted include Beijing Biren Technology and Moore Thread Intelligent Technology, two of China’s leading companies making graphics processors. Paul Triolo, who leads China and technology policy at advisory firm Albright Stonebridge Group, warned in a tweet the move could lead to China retaliation later in the year.
Also a risk: China’s increased intervention in its economy in recent years, which led to a crackdown of the country’s biggest internet companies. Beefed up anti-espionage rules and tightened data scrutiny also continue to dent business confidence and rattle global companies and investors.
Investors are taking different paths to avoid such risks.
MSA Capital—a China-based venture-capital firm which oversees $1.7 billion for institutional investors globally—has been repositioning for a couple of years as the U.S. and China increasingly view their relationship through a national security lens. Ben Harburg, managing director at MSA, says the firm has steered clear of businesses that could face restrictions from either country. Instead, MSA has pivoted toward life sciences, core technology, robotics, and logistics companies aligned with China’s policy priorities.
“A lot of people are burying their heads in the sand,” Harburg says. “There’s just one direction for U.S.-China relations and it’s getting worse.”
Such wariness about China is leading many asset managers to roll out new products all together, including a spate of emerging market exchange-traded and mutual funds that exclude China.
Other funds try to explicitly avoid risks borne out of the changing U.S.-China relationship. Harburg is managing one such fund, the
Core Values Alpha Greater China Growth ETF
(CGRO), which launched on Tuesday. The ETF tilts toward Chinese consumption-oriented companies—local travel, food, sportswear, beverage companies—and technology companies, such as those oriented toward making companies more efficient and helping China become more self-reliant. Roughly 20% is allocated to U.S. large-caps with considerable business in China, such as
Tesla
(TSLA) and
Apple
(AAPL). Not on the list are companies that could be targeted for national security concerns by either country, including
Baidu
(BIDU). The Chinese internet giant’s artificial intelligence business could put it in the sights of U.S. regulators down the line.
In the near term, Harburg sees consumer companies well-positioned to benefit as China’s economy stabilizes. He notes seeing lines out the door at coffee shops and fast-food chains, even as Chinese consumers are hesitant to spend on bigger purchases like cars.
While Chinese stocks might not fall much further on economic concerns, Harburg says more is needed for the market to actually recover. That could be a bigger batch of stimulus, or improvement on several economic metrics, like unemployment and the purchasing managers index. Or Beijing could deal with the financial distress that’s in the property sector—and among insurers and asset managers—with a possible bailout.
What isn’t clear is whether an upturn in Chinese equities—whenever it comes—will be used by investors to reduce their China stakes further, potentially limiting gains.
Write to Reshma Kapadia at [email protected]
Read the full article here
