Investors should consider selling down exposure to China in the face of a robust market correction in the country’s heady equity market, according to Hermes emerging markets chief Gary Greenberg.
The manager of the top performing Hermes Global Emerging Markets fund was previously very bullish on China, believing that often-touted worries of declining growth, popping property bubbles and ballooning debt had made China stocks cheap.
However, the various Chinese stock markets have seen an enormous rally over the past year following monetary easing by the Chinese central bank and a liberalisation of investment rules to open up markets to more foreign capital.
The rally has since started to peel away in recent months and the market has lost significant ground.
According to FE Analytics, the Shenzhen Stock Exchange Composite and the MSCI China have rallied hard in the past year, gaining more than 200 per cent in the case of the former – which has traditionally catered to domestic share ownership.
However, it is down 25 per cent since its peak while the MSCI China has lost 15.37 per cent since 4 April.
Performance of indices over 1yr
Source: FE Analytics
Greenberg has generally had a large overweight to China in his £330m fund but has been selling down exposure in the past month. He is still marginally overweight and says long term he thinks the market can go far, but he is expecting it as a whole to fall 15 to 20 per cent further.
But he adds that he will be buying into the correction and expects to up his exposure later in the year.
“I’m most worried over the A Share [onshore] market. Market conditions are not good. I recently returned from Shanghai and everyone I spoke to was 100 per cent certain that nothing could go wrong with the market’s rally. That’s just not the way markets work,” he said.
Greenberg’s Hermes Global Emerging Markets fund is top quartile performer – having beaten the sector and index over one, three and five years. It has returned 31.67 per cent over the past three years giving the fund the fourth best return in the sector.
Performance of fund, sector and index over 3yrs
Source: FE Analytics
Hermes Global Emerging Markets has a clean ongoing charges figure of 1.18 per cent.
However, the manager is not the only one who is wary of Chinese equities at the moment.
According to BlackRock global chief investment strategist Russ Koesterich, Chinese stocks are now on the cusp of a bear market following the “feverish rally” of the past 12 months or so.
He says the selling is most acute in small-cap and technology stocks, two sectors that have led the bull market of the past year and Greenberg has previously held.
“While we remain comfortable with China’s economic outlook, several factors suggest it may be too early to aggressively buy this market. First, China continues to be dominated by speculation. Even with the recent sell-off, margin debt remains close to an all-time high,” Koesterich said.
“Second, despite a near-20 per cent correction, equity valuations are still elevated relative to a year ago.”
Ratings agency Fitch forecasts that China's growth will slow to 6.8 per cent in 2015 and 6.5 per cent in 2016 as rebalancing away from an export-led economy towards a consumption led economy continues. It expect that India's growth rate this year will surpass China's for the first time since 1999. This view, that growth will decline quickly, is one of the primary worries for bears.
Josh Crabb, head of Asian equities at Old Mutual Global Investors, says the Chinese central bank’s recent move to cut its one-year lending rate by 25 basis points and to ease reserve requirements for commercial banks should prove a boon to boosting growth and markets.
“While there is no denying that Chinese equities have given back some of their earlier gains, we beg, politely, to differ with some of those commentators taking a negative view on the outlook for Chinese stocks,” he said.
“Our main contention is that the China bears are presenting an over-simplified case that fails to address the real situation of a large proportion of Asian equity investors, because it ignores the important differences between the Chinese mainland A Share market, and the H Shares of companies incorporated in mainland China, but traded on the Hong Kong Stock Exchange.”
“We have believed for some time that Chinese real interest rates were too high and that policymakers’ true desire was to ease monetary policy with a view to stimulating the real economy. The difficulty rate-setters were facing, however, was the seemingly unstoppable rise of the A Share market, which greatly weakened the case for monetary easing.”
Crabb says the unfolding crisis in Greece and a general trend of increasing bearishness in wider markets points to a belief that global markets are ‘in uncharted territory’.
“This led to increased volatility in virtually all financial markets, including in both the China A and H Share markets. Perhaps perversely, it is this very volatility that has enabled the Chinese authorities to engage in their latest round of monetary easing.”
