While most of the headlines of late have centred on worries over a ‘Grexit’ or more recently the chancellor George Osborne’s ‘radical’ Budget, Chinese equities have been plunging, fast.
Chinese stocks have been the big investment success story over the past year or so with the domestic index gaining more than 200 per cent over a 12-month period. Stocks available to overseas investors have also had a good run due to several moves to liberalise investment as well as central bank easing.
According to FE Analytics, the Shanghai index is down 32 per cent over the past month, the MSCI China is down 20 per cent and the best performing fund in the IA China/Greater China sector – JPM Greater China – lost 10.73 per cent.
Performance of sector and indices over 1yr
Source: FE Analytics
The previous best performer in the sector over one year – the $450m New Capital China Equity fund managed by FE Alpha Manager Mansfield Mok – is now the worst performer over the past month and the second worst over three and six months.
Performance of fund, sector and index over 5yrs
Source: FE Analytics
Mok has a large overweight to financials, which represents about a third of the portfolio. This part of the market has been the most volatile. Over the longer term it has meant his fund has significnatly outperformed.
Dale Nicholls, manager of the well-known Fidelity China Special Situations investment trust, is using the correction to add to existing holdings and recommends – perhaps unsurprisingly – investors use it as a buying opportunity.
“Investors have clearly been spooked by the correction in the markets, but I think this is overdone and is creating good buying opportunities,” he said.
“The fundamental case for China remains intact: growth remains strong in a global context, especially in the area of consumption, which is supported by long-term trends such as urbanisation. The path for reform is set and this will continue to create opportunities, especially for innovative private companies. Stock picking will be key.”
“Recent events have shown that the rapid growth in margin-led investing clearly got ahead of itself in the sharp market run and we are now feeling the effects as this is unwound. This will likely take some time and markets will remain volatile. Policy response on the whole has been disappointing and in many ways runs contrary to the spirit of broader reforms and general market liberalisation.”
Nicholls adds that falls in some stocks are “clearly overdone and offering real value”.
“China is an immature market and there are many issues that need to be addressed, but it is also offers great opportunities for stock pickers given the strong structural growth opportunities and valuation anomalies in the market,” Nicholls said.
However, not everyone is so sanguine. The huge falls have undermined the government’s credibility at managing market levels, says the equity strategy team at Bank of America Merrill Lynch.
The team thinks this could lead to a full-blown crisis for China stocks and the overseas funds that invest in them.
“If the market continues to fall sharply, stock lending related losses could run into Rmb trillions, of which banks and brokers may have to bear a meaningful share. These potential losses can be especially dangerous to brokers whose capital base is less than Rmb1trn,” they said.
“Even more important, the opaqueness of China’s financial system and the lack of clear definition of risk responsibility mean that contagion risk is high, similar to the subprime crisis.”
“What has happened in the stock market has likely increased the risks considerably and also brought forward the timeline by our assessment – the leverage is much higher now and economic growth rate, potentially lower.”
They say there is likely to be a big dent to the market’s ‘faith’ in the role the government has traditionally played in shoring up confidence.
“We believe that the biggest damage caused by the A-share market’s rollercoaster ride since the middle of last year has been to investors’ faith in the government’s ability to manage asset prices (stock, RMB, debt and even property) reasonably smoothly.”
“The difficulty the government has faced to stabilise the stock market has demonstrated the downside of that faith. As a result, we expect many of these assets to be re-priced lower going forward. Also, the ripple effect from the market correction has yet to show up – we expect slower growth, poorer corporate earnings, and a higher risk of a financial crisis.”
Nigel Green, chief executive of deVere Group, says China’s stock market falls should act as “a wake-up call’ for investors. He says they should urgently reassess their portfolios.
“Much of the world’s attention is on Greece right now. Whilst it is right that investors keep a close eye on the Greek saga, one eye must remain firmly on the burgeoning crisis in China,” Green said.
“China’s government and regulators appear to be pulling out all the stops to support share prices – including a defacto suspension of new listings and interest rates being cut to new record lows – although investors seem to be unconvinced that this will help. Despite few foreign investors having much exposure to the Chinese stock markets, the meltdown matters.”
“Indeed, it is hugely significant because it will send shock waves throughout global capital markets, not least because China is the world’s second largest economy and one of the largest consumers of commodities and other goods sold by other countries.”
Green says it is therefore China and not Greece that should be the main cause for concern for investors at present for their broader exposure to markets.
