The weakness in China is a deteriorating trend that could become worse over the next 18 months or more, according to Fidelity’s Kevin O’ Nolan (pictured). 
The manager, who co-runs the Fidelity Multi Asset Allocator Growth, Strategic and Defensive funds among others, says that China is the single headwind he’s most worried about at the moment and has positioned his portfolios accordingly.
Investors that have been paying attention to financial media outlets over the last few months will have noticed that ‘China’ and ‘oil’ have been the overwhelming focus of most industry commentary.
Events came to a head in China during August year following its overcapacity, its growth slowdown and the subsequent mass sell-off of the Shanghai Composite index.
Performance of index in 2015
Source: FE Analytics
Oil has been more of a longer term trope, with prices falling since 2014 as a result of oversupply from the US and Canada, a global lack of demand and Saudi Arabia’s decision to keep its production stable despite falling prices.
There are many investors, including various professionals, that have become tired of so-called ‘fear mongering’ surrounding these issues, arguing that the potential long-term impact of these factors has been blown out of proportion.
FE Alpha Manager David Coombs, head of multi-asset at Rathbones, used last year’s sell-off in China to add to his Japanese, Chinese, wider Asia and emerging market exposure within his Strategic Growth portfolio.
“We look back at taper tantrums or Lehmans or the dotcom bubble or Greek debt drama and there’s usually some kind of underlying crisis that creates this sort of panic,” he told FE Trustnet in September.
“The fact is that [the sell-off] happened in August and volumes were relatively low, and I think high frequency traders have had a bigger impact on the market than maybe they do at other times.” “I don’t understand why the fact that China is slowing is creating this effect. Everyone knew China was slowing. Most big corrections are due to a shock and I don’t know what the shock is here.”
M&G’s Steven Andrew agrees and, at the end of last month, he said that negative investor sentiment surrounding China is due to sensationalist articles written by investment writers.
“It’s very important when you’re listening to [investment writers] spinning a load of yarn about the future and telling you a narrative about recession and about China falling so quickly that it’s inevitable that it leads to a disaster, to look at the explanation,” he said.
“You have to try to draw a straight line between ‘cause’ and ‘effect’, because not a single [investment writer] is going to articulate that properly in terms of how China slowing down turns into bad news for us fundamentally.”
However, there are of course a number of investment professionals that remain unnerved by China’s slowdown, and O’ Nolan says it has been responsible for more of the volatility and disappointing returns in stock markets than people realise.
He also believes that this is set to continue and even worsen as policy makers ease back from giving China’s growth a helping hand.
“If we look at the weakness in emerging markets since 2010 when it peaked out, for us there has been three drivers. One is the stronger dollar, two is weaker commodities and three is what’s happening in China,” the manager said.
“If I really had to pick one and break it down I think it’s all about the weakness in China. You have this structural story of effectively an ever-increasing growth number, a sharp move lower in 2008 and a bounce back with fiscal policy, but that has now been on a deteriorating trend really since 2010.”
“In my view that trend has considerably further to go - I think growth is being artificially smoothed so the pace of slowdown is slower than it should be because policy makers are actively working against it. I think that’s showing up in different places.”
He adds that China’s CPI has been negative for four years, which suggests there is overcapacity in certain industries. He says that this is able to continue because the banking system is largely centrally controlled, and that there has been a significant increase in the leveraging of companies and evergreen loans.
“This is going to be an issue. It’s very difficult to tell when and it’s one of the reasons why you have to be very careful about how you express a view on this in your portfolio because it might not come to roost for a long time. As such we try to introduce positions that will work well in and of themselves,” O’ Nolan continued.
Across his funds, the manager invests in various derivatives and index-linked investment vehicles. One position he has been playing recently is the Indian rupee relative to the Singapore dollar and the Korean won, as he says the two short sides of the trade are sensitive to the behaviour of the renminbi.
He adds that the growth differential between the plays looks attractive, and explains that risks of low inflation in Singapore and Korea suggest that monetary policy in these regions will be much looser than in India.
“I think a lot of my positions have an element of trying to hedge against certain outcomes in China,” he said.
“Another one that we have is Australia relative to Hong Kong. They’re both developed markets but they’re both very exposed to China, we just think Australia has the added benefit of its own unpegged currency and the ability to ease monetary policy, whereas Hong Kong is very much tied in as a peg to the dollar but it’s also more directly tied into the weakness of what happens in China.”
“I think the China story is going to come in waves and it may fade into the background for a little bit if growth looks slightly better, but I do think that over the next 18 months-to-two years this is going to remain a big focus.”
Since O’ Nolan began running funds for Fidelity in 2015, he has underperformed his peers by 79 basis points with a loss of 6.12 per cent.
Performance of manager vs peer group composite
Source: FE Analytics
However, he has outperformed his peer average year-to-date with a loss of 4.07 per cent compared to his composite’s loss of 4.7 per cent.
