Investors should wait to buy back into China until the execution of exchange rates reforms have finished, according to James Dowey (pictured), chief economist and chief investment officer at Neptune Investment Management, after which he says the market can recover.
The Chinese equity market’s – mostly – ongoing plummet over the past eight months has stepped up a level recently as poor economic data brought about a hefty risk-off start to 2016, which dragged the FTSE World index down further as a consequence.
This has meant a torrid time for emerging markets and specialist China funds with the average in the IA China/Greater China sector down 8.88 per cent year to date with almost a quarter down double digits.
Performance of sector and indices in 2016
Source: FE Analytics
Dowey says because the Chinese currency, the renminbi [RMB] is pegged to the US dollar it has recently been coming under pressure as US monetary policy is ‘exported’ to China and the dollar has been strengthening.
“This means that a strong US economy and a weak Chinese economy give rise to a tug of war at the centre of the global financial system. However, I believe the market’s gloom and doom is over the top,” he said.
“This is because the policy solutions are simple, feasible and being executed by the US and Chinese authorities. They are threefold and work best in combination.”
First the Fed must “tread cautiously”, he says, with regard to its next rate hike in 2016 and by only expressing to investors that this will happen when markets have calmed from their current volatility.
“This is exactly what the Fed did last September, when it decided against raising interest rates at that time. I believe it will do so again with respect to the next rate hike.”
“Second, China can use fiscal policy to adjust domestic demand conditions to a strong exchange rate – and this is what the Chinese government is judiciously doing.”
“Third, China can change its exchange rate policy, by allowing the RMB to depreciate against the US dollar in the face of US dollar strength, and – given the authorities’ reluctance to allow the RMB to float freely at this point – manage it against a basket of major currencies rather than the US dollar alone. Again, this is exactly what China is doing.”
However, he concedes that investors are not expecting this to happen any time soon, which explains the consistent bearish stance towards China as well as the broader market.
Simon Cox, investment strategist at APAC, part of BNY Mellon Investment Management, thinks the current volatility in global markets – in particular China – has the same cause as the Black Monday sell off in August last year and the a rally after the event at this time [shown below] could occur.
A poor understanding of the Chinese authorities’ stance on its exchange rate has coupled with ‘clumsy’ market interventions to make investors believe they are incompetent, he argues.
“Global investors have strongly reacted to events, just as they did in August 2015, when Beijing unexpectedly devalued the yuan,” Cox said.
“On both occasions, outsiders interpreted the currency moves as a sign that China’s officials knew something about the true state of the economy the rest of us did not. I believe that was a misinterpretation of the August devaluation and I think it is an over interpretation of the currency depreciation.”
“China’s economy is weak, but no weaker than we already knew. Just as global markets staged a relief rally in October 2015, they may recover their composure after the recent sell-off.”
Our data show that it was well worth buying back into China at the nadir of the 2015 market on Black Monday with the market rocketing back up.
Performance of sector and index 25 August to 1 December 2015
Source: FE Analytics
Global stocks have now fallen for seven consecutive sessions and oil has joined the rout as investors expect its demand to suffer due to slowing economic activity from China and the deprecation of the Chinese currency against the US dollar.
Performance of index in 2016
Source: FE Analytics
Dowey says the latter reason does not warrant the current turmoil evident in the graph above. This can only mean the market has a “trust issue” with the Chinese government, he says.
“The market supposes that there is a significant chance that rather than duly following the prescription of the economics textbook, the Chinese government has simply lost control, with currency weakness being a manifestation of the demise,” he said.
“This is understandable given the poor quality of Chinese economic data, government policy opacity and the folly of the government’s attempts to control the stock market since last summer, which have hurt its credibility,” he added.
“However, I do not think it is the correct interpretation of what is going on in China. The market is worried about knock-on effects of a weaker RMB on China’s trade partners.
While this is understandable, he thinks, markets are already expecting a dire performance for emerging economies in the near term. This is because of slowing Chinese growth and tightening US monetary policy and therefore the panic selling evident recently is unlikely to get worse, he argues.
“With emerging markets equities at one of their cheapest ever levels in history, it is not as though the market is in need of a reality check on emerging markets.”
“As such, we expect to see markets negotiate this hurdle once they get better visibility concerning US and Chinese policy, and some evidence of its positive effect on the Chinese economy.”