While browsing through all the predictions for next year, I noticed that hardly anyone dares to put China on the map. Until I recently saw JP Morgan’s outlook with the appealing headline “Buy everything in China”. This was followed on Tuesday by Goldman’s statement that all the risks in China have now been factored in.
The immediate cause for this enthusiasm is the recent easing in Chinese monetary policy, almost at the same time as the Fed, forced by rising inflation, announced an accelerated reduction in the buy-back programme and a possible threefold increase in interest rates next year.
Not the year of the bull
On 18 February this year, I wrote a column for Fondsnieuws (Investment Officer Luxembourg’s sister publication) suggesting that Chinese stocks should be exchanged for Chinese bonds. At the time, MSCI China was 45 per cent above its 2020 peak and, especially in the first six weeks of 2021, it was doing well, gaining 20 per cent. Yet there were plenty of clouds on the horizon. The peak in the Chinese stock market coincided with the peak in economic growth in the country. This while growth in other regions, such as the United States and Europe, was still being constantly revised upwards.
So much so that the US economy could well grow faster than the Chinese in 2021. Nevertheless, everyone remained enthusiastic about Chinese growth, except the Chinese themselves, who did not want to go beyond a growth rate of 6%. But then, the Chinese government had inside information. In the summer of 2020, Beijing had announced the Three Red Lines policy to curb credit growth among property developers, but without the desired effect.
House prices continued to rise, despite Xi Jinping’s clear statement that houses are for living in, not for speculating in. Monetary policy was also not expected to be eased for the time being. Nevertheless, the Chinese stock market was valued at the highest level in the past nine years. Meanwhile, the MSCI China is more than 30 per cent lower than in mid-February this year. This is while the US stock market has risen by 20 per cent since then, leading to a historically large yield gap between China and the US. The swap to Chinese government bonds has worked out well, rising by more than 10 per cent since February.
Ten reasons to get into China now
1. The main reason to invest more in China is the turn in the Chinese liquidity cycle. In the past, there has been a strong correlation between stock market returns and monetary policy. Moreover, policymakers have explicitly stated that they want more growth.
2. Furthermore, China is underrepresented in foreign investors’ portfolios. This is partly due to the policy of gradually increasing the weight of, for example, MSCI. Recently it became possible to go short on the Chinese index and for MSCI this will be a reason to increase the weight of China in the world index in 2022. The same also applies to Chinese bonds.
3.Chinese are also going to buy more shares themselves. Although there is a real positive interest rate in China, more than 60 per cent of wealth is in the housing market. With new home prices falling for three months in a row, interest in equities will increase as the stock market rises. In many developed countries outside China, only a quarter of equity is in the home.
4. Besides equities, Chinese government bonds remain attractive. Positive real yields, a healthy monetary policy and the ambition to position the renminbi as a reserve currency alongside the dollar ensure that the currency can appreciate further in the coming years.
5. ;The turning point for the Chinese equity market is strikingly often around the turn of the year. This may be due to institutional investors daring to take more risk, but the noise surrounding the Chinese New Year will also play a role.
6. If China wants to stimulate economic growth, this means they will be less strict with new regulations. In recent months, there has been a lot of news about new regulations having a negative impact on economic growth.
7. Evergrande and Kaisa are now officially in default. That means property business, end of entertainment. A long restructuring process will follow, but no second Lehman.
8. There is now an energy shortage in China, so energy-intensive factories are being shut down. This is now at the expense of growth, but at the same time is the basis for a potentially strong recovery.
9. The way for the US government to reduce inflation is to ease Trump’s trade sanctions. The American voter cares more about inflation than China and next year the Democrats risk losing the majority in Congress in the mid-terms.
10. Fuelled by the media and the striking cooperation in the US between Democrats and Republicans on China, investor sentiment towards China is extremely poor, an excellent counter-indicator.
The importance of China in the portfolio
The Chinese equity market and the Chinese bond market are the world’s second largest after those of the United States. On the basis of purchasing power parity, China is the largest economy in the world, some 20% larger than the United States. China is then about 20 per cent of the world’s GDP. China’s importance to the growth of the world economy is much greater. Few investors outside China will hold more than 20 per cent in Chinese equities, despite the sharply increased appeal. In fact, now would be the time to consider Chinese equities.
A 20 per cent weighting in Chinese bonds is completely unprecedented, while this is about the last investment grade market that still has a positive real return. It is incomprehensible that bond investors continue to allocate to countries where the monetary madness has broken out. A heavy weighting of China in a portfolio also provides a better spread of risk. In a tripolar world with a dollar block, a euro block and a renminbi block, an equal distribution would not be out of place.
Han Dieperink is an independent investor, consultant and knowledge expert for Fondsnieuws. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co. He is currently active as chief commercial officer at Auréus Asset Management. Dieperink provides his analysis and commentary on the economy and markets. His contributions appear in Dutch on Fondsnieuws on Tuesdays and Thursdays and occasionally in English on this site.