Chinese equities have rallied hard over the past month or so, driven by expectations of further stimulus from the authorities to combat economic weakness and a programme to increase investment between mainland China and Hong Kong.
As an article this morning showed, the IA China/Greater China sector has been the best performing peer group over the year to date, with the average member returning 24.57 per cent since the start of 2015.
The highest returner has been Michael Lai's GAM Star China Equity fund, which is up 32.24 per cent, followed by Mandy Chan’s HSBC GIF Chinese Equity at 30.02 per cent and William Fong’s Baring China Select with 29.99 per cent. Even the sector’s worst performer, Aberdeen Global Chinese Equity, has made 15.28 per cent.
IA China/Greater China’s closest competitor year to date is IA Japanese Smaller Companies, where the average gain is 20.29 per cent. It is ahead of more mainstream sectors by a much wider margin: IA UK All Companies has gained 8.86 per cent, IA Global 10.76 per cent and IA Global Emerging Markets 13.27 per cent.
Performance of sectors over 2015 so far
Source: FE Analytics
Those watching the markets rather than fund sectors will have noticed the strong returns made by Hong Kong’s Hang Seng and Shanghai Composite indices over recent weeks. The Hang Seng is up more than 20 per cent since the start of the year, while the Shanghai Composite has surged more than 30 per cent.
One reason behind the rally is the Shanghai-Hong Kong Stock Connect programme, which was launched in November 2014 allows private investors and fund managers in mainland China to trade in Hong Kong-listed stocks and vice versa.
The rise in Hong Kong stocks follows a relaxing of rules to allow more Chinese fund managers to invest in Hong Kong-listed shares. As these H-shares were at valuations about 33 per cent cheaper than the A-shares traded in mainland China, many managers made use of the programme.
But the ascent of the indices since the launch of Shanghai-Hong Kong Stock Connect – the Hang Seng has risen close to 25 per cent since the start of November 2014 while the Shanghai Composite is up close to 80 per cent – has left some investors cautious about the outlook for further gains.
Mark Williams, co-manager of the Liontrust Asia Income fund, believes such fears are overdone.
“This has caused many market commentators to loudly cry ‘bubble’, but we believe the rally in Hong Kong-listed Chinese companies may still have some time to run,” he said.
“Since the initiation of the Shanghai-HK stock connect in November 2014, many have focused on the increased scope for overseas investors to invest in mainland China’s A-shares, and attempted to link this to the rising premium at which A-shares trade over their H-share counterparts.”
“Although the Shanghai Stock Exchange Composite Index has doubled since January 2014, touching 4,000 intra-day, the previous peak of 6,092.06 in October 2007 is still far away.”
“While the valuations of many of China-listed A-shares appear to be straying from fundamentals, the Hong Kong-listed H-share equivalents which we invest in still tend to trade at a significant discount to their Chinese siblings. This is reflected in the lower, although still strong, performance of the Hang Seng China Enterprises Index.”
Liontrust Asia Income has around 45 per cent of its portfolio in Hong Kong-listed Chinese businesses, including the likes of Great Wall Motors, Bank of China, China Mobile and Industrial and Commercial Bank of China.
Despite the recent strong moves in Hong Kong shares, Williams maintains that they are still attractive on a longer term view.
“There may be positives to drive the rally further, with the possibility of further Chinese monetary easing, measures to ease access to the Hong Kong shares for domestic Chinese mutual funds and retail investors, and inclusion of a Shenzhen-Hong Kong stock connect later in the year.”
However, Rathbone Global Opportunities fund manager James Thomson believes that investors should be cautious about chasing the recent gains in Chinese stocks, arguing that some of the inflows moving the market could be short term and speculative in nature.
He sees Shanghai-Hong Kong Stock Connect as “a new avenue for speculation”.
“I think people should be a little bit wary about the hot money that seems to be flowing into Chinese and Hong Kong equities, especially when you contrast that with some pretty weak economic data coming out of China,” he said.
“I heard one commentator speaking recently about how it is really encouraging that the gambler and speculator-types have access to the market, especially now that property seems to have been pushed out.”
Economic data coming out of China has hardly been cheerful, as Thomson notes, and does not seem to justify the surge in share prices.
Yesterday, monthly trade data showed China’s exports dropped 14.6 per cent year-on-year in March, significantly missing analysts’ forecasts of an 8 per cent or more rise. But despite this Chinese stocks rose.
Likewise, the market has continued to rise even though profits of Chinese industrial businesses declined by 4.2 per cent in the first two months of 2015 while electricity consumption – which is a good proxy from economic activity – fell 6.3 per cent in February.
Thomson describes the economic data coming out of China as “dreadful” and says one reason why they have led to stock price increases is investors hoping that it will lead to more stimulus, such as interest rate cuts or even a form of quantitative easing.
However, the FE Alpha Manager argues that this is not good grounds for long-term investment.
“We should be cautious about the hot money going into that part of the world. It’s probably trying to predict interest rate cuts and quantitative easing-style stimulus. This will also be very topical this week as we’re getting GDP data from China. A lot of people are saying that 7 per cent is the line in the sand and if it goes below that then it looks like more stimulus will be on the way,” he said.
“In my mind, that would be a symptom of a wider problem – that they’re not able to rebalance the economy as they promised. The rebalancing towards consumption is going to be a much more difficult process to enact than it is to say.”
“That’s why we stay very cautious, we’re not trying to bet on interest rate cuts or QE. We don’t think that’s a sustainable way to make money; you really want self-sustaining economic growth. For my money, I’m trying to stay clear of all the dangerous imbalances I see in places like China.”
