Emerging Markets: why it’s time to look beyond China
Our Emerging Markets fund managers have reduced weight in China after spotting challenges to Chinese equities — and some highly attractive opportunities in other markets.
Here James Syme and Paul Wimborne (pictured above) — managers of Pendal’s Global Emerging Markets Opportunities strategy — explain the details.
CHINA was the first country into the Covid crisis, one of the (predominantly Asia-Pacific) countries that seemed to manage the pandemic well — and the first emerging market to show economic recovery in mid-2020.
This was partly due to the general normalisation of domestic conditions as lockdowns were removed. But it also came on the back of a marked shift to a more stimulative monetary and fiscal policy.
A long period of tighter policy that China put in place to slow the build-up of debt in the economy was eased in the first quarter of 2020. This helped drive the construction and real estate markets through the rest of the year.
The heavy weight in internet and technology service businesses in Chinese equity markets was a significant additional boost. Even at the start of 2020 this group of companies made up more than 37% of the index weight in the MSCI China index.
A significant, Covid-driven boost to gaming, online media consumption and e-commerce — coupled with strong investor preference for this sector — drove strong performance among these stocks and lifted the overall market higher.
Challenges to Chinese equities
Now, however, we see some challenges to Chinese equities, and have responded by reducing our weight in the country — especially in light of some highly attractive opportunities in other markets.
Signs of a slowdown in Chinese activity in the last quarter of 2020 are the first of these challenges.
This is by no means a crisis. But PMI data through the year-end came in below consensus expectations. November retail sales, while up 5% year-on-year, indicated there had not been a bounce-back in the Chinese consumer to make up for a Spring downturn.
This stands in contrast to several other big emerging markets, where data continue to surprise as recoveries come through.
Other indicators such as parcel delivery volumes and traffic congestion also suggest a softening of activity in November and December. Outside China, Korean exports were up 12% year-on-year in December, but Korean exports to China rose only 3%.
Earnings estimates trimmed
This softness has also come through in earnings estimates.
Consensus estimates of earnings for many Chinese companies were trimmed in the last three months — exactly at the time it seemed the global economy was accelerating and consensus earnings estimates were revised higher in many emerging countries.
Significantly, China lagged Korea and Taiwan in the last quarter on this measure after it tracked them through most of the rest of the year.
Politics and policies
The other set of challenges concern politics and policy — both within China and internationally.
Domestically, fallout continues from Alibaba founder Jack Ma’s October speech in which he criticised Chinese regulators.
Regulators promptly cancelled a planned US$37 billion listing of digital financial services company Ant Group (which counts Jack Ma as a founding shareholder).
In December the State began a full-blown anti-trust investigation into Alibaba. This caused a sharp decline in its share price — and related weakness in other Chinese internet and technology service businesses as investors adjust to what may be a more difficult operating environment.
US investor restrictions
This happened at broadly the same time the US government was ratcheting up restrictions on US investors investing in Chinese state-owned enterprises — principally by targeting the US secondary listings of such companies.
A November presidential executive order prohibits new investments in securities of Chinese businesses that the US government believes have links to the Chinese military.
This could potentially hit many listed companies. In the first instance it led to the delisting of three state-owned telecom companies from the New York Stock Exchange (and the removal of those securities from the MSCI China and MSCI EM indices).
It’s particularly concerning that the executive order may also affect US investors’ stakes in other US-listed Chinese companies — including most of the internet names — and also products such as ETFs and derivatives based on various Chinese equity indices, including the Hong Kong Hang Seng Index.
How we’re responding
We had already reduced exposure to US-listed Chinese State-owned enterprises (SOEs) in the portfolio in 2020, selling CNOOC, Sinopec and China Mobile.
We have further reduced our weighting in China, partly in response to the concerns highlighted above and partly in response to the much better macro environments we find in some other emerging markets.
James Syme and Paul Wimborne are senior portfolio managers and co-managers of Pendal’s Global Emerging Markets Opportunities fund.
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