In recent days we have seen a massive correction in Chinese stock markets, both in Hong Kong and the mainland. This was due to particularly strict regulatory measures taken by the Chinese government around education stocks.
Jeroen Blokland argues that Chinese stock markets have now entered a bear market. For example, the FTSE China A50 Index, which includes the 50 largest A-shares in terms of market capitalization, is now down as much as 24 percent from its peak in February. The shock waves were felt all the way to the West. For example, Prosus, whose net asset value is largely made up of Tencent shares, lost some 15 percent in two trading days.
An unexpectedly strict regulation restricting private education companies was the trigger. Investors fear the problems will trickle down to other sectors. This is a stark reminder that China remains a centrally planned economy. According to Blokland, investors will now demand a higher risk premium for Chinese stocks.
Further impact
The government intervention is not just bad news for Chinese equities as China has a weighting of some 40 percent in the MSCI Emerging Markets Index, which has corrected by more than 12 percent from its peak in February and has already given up this year’s gains.
Blokland mentions that the outlook for emerging markets was already less favorable than that for developed markets anyway due to less fiscal stimulus, an increasing number of central banks tightening monetary policy, a stronger U.S. dollar and last but not least a slow-moving vaccination campaign. Blokland: “That is why we remain underweight in emerging market equities relative to developed markets.”
Alternatives
Investment Officer also spoke with Jan Boudewijns (photo), head of Candriam’s emerging markets team and one of the most experienced emerging market investors in our country. Boudewijns mentions that “after the onslaught on Internet services and the real estate sector, China’s education sector is now being hit by the wave of stringent regulation.
The long-term goal is to improve the lives of the Chinese and make them more affordable. In this way, the aim is to encourage families to have more children and to rectify China’s deteriorating demographics. We think education stocks have corrected sharply, but the outlook remains dim or at least very uncertain. In our opinion, it is not a good idea to invest in this sector right now.
Boudewijns’ team had already downgraded the sector before the recent correction. In their China exposure, they are also underweight in Chinese Internet and US-listed ADRs, and overweight in A-shares, with thematic emphasis.
Boudewijns mentions that there are alternatives to these stocks. He argues that China is clearly reforming the country with a long-term view. So the wave of tighter regulation is probably not over yet. “As a result, selling pressure may continue unless China reverses its recently instituted tighter monetary and fiscal policies. The alternative for investors who want to stay in emerging markets is to invest in a globally diversified portfolio, in which the portfolio manager can adjust the allocation between different markets and sectors as needed.”