China-focused funds are the best performing of any world region so far in 2020. Perhaps surprising in the context that the Covid-19 pandemic that has devastated stock markets globally, started in China. Does this moment mark a definitive shift in the balance of power in financial markets? And if so, should investors be reconsidering the geographic mix of their portfolio allocation?
The coronavirus pandemic sweeping the world and putting global economies into a hibernation that is expected to give way to recession started in the Chinese city of Wuhan. Weeks before anyone in the West seems to have been overly troubled by another nasty virus emanating from Southeast Asia, henapaviruses, SARS and avian, or ‘bird’, flu also started in the region, Wuhan was sealed off by Chinese authorities Nobody was allowed in or out.
But the rapid, at least once the ruling Communist Party of the People’s Republic of China became fully aware of the seriousness of the situation, and decisive moves to contain the spread of Covid-19, mean China’s economy has returned to action relatively quickly. Far more quickly than it looks like will be the case for the other economies the virus subsequently spread to.
That’s now reflected in the performance of equity funds since the beginning of the year. The clear winners are now those from the China and Greater China, which includes Hong Kong and Taiwan, sectors. Funds invested in Chinese stocks are outperforming those invested in companies from the UK, Europe, Japan, other major Asian stock markets like South Korea and Singapore and the USA.
Is China’s Stock Market Decoupling From The West?
From a position of being down 10% for the year, the Shanghai index, China’s most closely followed benchmark, has recovered to a level just 3% lower than where it began 2020. That’s despite having recorded a less impressive start to the year than Wall Street that was, at its mid-February peak, up 7%. It’s now down more than 8%, despite a positive rally over the past few weeks.
Source: The Times/FE fundinfo
A growing number of analysts are of the opinion that this could mark a watershed moment. The point where China’s economy and financial markets start to forge their own path and are no longer as closely tied to the West as they have been.
For decades, China, along with other ‘emerging markets’ in Asia have reflected a more volatile reflection of what happens on Wall Street. When the major U.S. indices have move up, emerging markets have too – often to a greater extent if with a delay. When Wall Street has lurched downwards, emerging markets have fallen hard. This coupling, as well as the relative correlation of other developed markets to Wall Street, gave birth to the now unfortunate saying of “when the US sneezes, the rest of the world catches a cold”.
Historically, China’s fortunes have been particularly closely tied to those of developed economies, especially that of the USA. China’s factories and exports-orientated economy has always relied on external consumer demand.
The transition to an economy more driven by domestic consumer demand has been a slow one and proven more difficult to achieve than China’s authorities had hoped. But in recent years headway has been made. Matthew Dobbs, who manages Schroder’s Asia Pacific investment trust explains:
“Economically China has already significantly decoupled from the US. The US now accounts for only about 25 per cent of Chinese exports, similar to the amount taken by Europe.”
Ironically, Trump’s recent trade war with China has accelerated its economy’s falling reliance on the USA as an export market. The USA now buys around 25% of China’s total exports, down on previous years, and roughly in line with Europe.
China’s stock market is also much more domestically orientated that any other major international stock market. That’s because a large majority of its investors are domestic. Only 2% of Chinese equities are owned by overseas investors. Another striking and significant statistic is that 87% of the shares listed on China’s stock markets are held by retail investors – private individual and households. That’s very different to the situation in developed markets. In the USA, only 37% of Wall Street-listed stocks are held by retail investors. 20% are held by overseas investors.
In the UK, the influence of global financial markets on the London Stock Exchange is even more pronounced. As of 2018, more than half, 55%, over London-listed shares were held by non-UK domiciled investors. Somewhere around 12% are held by UK retail investors.
JP Morgan Asset Management’s Tai Hui sums the alternative nature of China’s equities market up with:
“Its investor base is overwhelmingly domestic and capital controls have played a part in separating Chinese and international markets.”
That also touches on the fact that unlike investors elsewhere in the world, Chinese investors have little choice but to keep their money domestically. Over the last couple of decades, a trend that has accelerated over the past several years, online investment platforms have made it easy for retail investors to invest almost anywhere in the world. That’s highlighted by the fact China and Greater China-focused funds available to us, are outperforming those invested in U.S., UK and European equities.
Chinese investors don’t have the same choice due to capital controls designed to keep a majority of wealth circulating internally. China’s institutional investors are also obliged to invest the lion’s share of the assets they control at home.
China’s Economy Will Recover Fastest From The Covid-19 Pandemic
Economic analysts, including those at fund manager Fidelity, also believe the global bounce back from the Covid-19 pandemic-induced lockdown will also be led by China. The rapid, strict and coordinated action taken to control the outbreak, far easier for the country’s authoritarian regime than for Western democracies, also means China’s economy is likely to be the least damaged.
A poll of analysts covering China saw 85% say they believe company earnings will only suffer over the first half of 2020. A majority of analysts covering other international regions expect the hit to revenues to continue deep into the year, if not 2021. One analyst, who has insight into over 100 Chinese factories, is reported by the Financial Times as confirming that by March 9th, 92% were already operating again having all been closed in February.
Threats To China’s Faster Stock Market Recovery
China’s stock market isn’t however, free of any threats to its performance over coming months. Most of the country’s major indices are strongly influenced by just two giant companies – ecommerce giant Alibaba and Tencent, the internet and gaming giant. Together their weighting accounts for as much as 30% of the Shanghai index’s total market capitalisation.
In the UK the oil majors of Shell and BP accounted for around 20% of the FTSE 100’s total weighting before the recent slump in oil prices and the FAANG stocks + Microsoft make up about 15% of the S&P 500’s total strength. However, no other major market is quite so dominated by two giant companies as China’s.
Both, making their money online, are relatively well placed to come through the lockdown in good shape. Alibaba is the more vulnerable as it relies on factory output and international supply and delivery chains. But still, like Amazon in the USA, the company should prove far more robust than bricks-and-mortar competitors or smaller online rivals with far fewer resources. But if they do start to suffer, China’s indices will take a nosedive.
James Anderson, manager of the Scottish Mortgage investment trust is heavily invested in China and counts both Alibaba and Tencent in his five largest holdings. He believes the balance of global economic power will be fought out between the USA’s west coast and China’s east coast over the next two decades. But with the overall size of China’s economy almost certain to pass that of the USA in the next ten years, time is on the Asian competitor’s side.
Food for thought for investors who have yet to take the plunge and add China exposure to their portfolio.