Schroders recently held an online conference on the Chinese financial markets, with three experts giving their insights for the current year. After a strong outperformance in 2020, China should see its growth accelerate in 2021, with the domestic sectors being supported by the stimulus measures while the cheap cyclical sectors will be supported by the better outlook for global growth and international trade.
Tectonic changes
But before getting deeper in the different asset classes, Alan Ayres (Client Portfolio Manager Emerging Markets Equity at Schroders) gave an introduction on the emerging markets universe. “This is a very diverse asset class, with countries at very different stages of development. While a lot of the emerging countries are poor, many are not, and we should really be thinking in terms of capital market development, not simply in terms of economic growth”.
While he points out that the economic growth is often linked to higher market returns, it is not sufficient to explain the outperformance over the long term. “The regulatory framework, the education system and the role of the capital markets in the economy can be just as important. This specific factor can be targeted by focusing on countries which are set to improve on these criterias in the future. And China would be a good example of a country that fits this model, especially since its entry in the World Trade Organization back in 2001”.
For 2021, Alan Ayres underlines the impact of the dollar on the EM asset classes. “Despite the rise of domestic demand and the reduced importance of commodities, the asset class remains a high beta play on global growth and on the depreciation of the US dollar”. After its decrease in 2020, the US currency is now close to fair value, but with prospects for further depreciation with the additional fiscal spending planned over the coming months. “We should nevertheless keep an eye on the Chinese central bank, when they start to tighten their interest rates. But if we are right about the dollar and the bounce back in global growth, flows to China should continue to be strong”.
New China
Regarding the Chinese equity market, Stephen Kam (Investment Director for Asia Ex-Japan Equities at Schroders) expects the market to be driven more and more by the domestic markets, with investments increasingly geared towards strategic areas (IT infrastructure, biotech, and so on) and less towards big infrastructure projects. “With the demographic situation of the country, the productivity gains will be of strategic importance going forward, and we expect to drive our investments towards these areas (for instance automation and robotics)”.
At the same time, Stephen Kam points out that China still represent only a small portion in the asset allocation of international investors. “The domestic A-shares market is an exciting and new opportunity, and you will find most of the companies geared towards the domestic consumption on the Shanghai and Shenzhen stock exchanges”. The domestic market is furthermore dominated by retail investors, which has allowed active managers to outperform the market indexes in recent years.
The next few months should remain favorable for the Chinese stocks, with a positive outlook for earnings and a smoother economic path of normalisation compared to developed countries. “Valuation is the main challenge at the moment after the strong performances of 2020, and we need to be more selective to find good and attractively valued opportunities”, for instance in the component makers for the automotive industry or the technology hardware space.
Currency support
For the bond market, David Cheng (Investment Director for Asian fixed income at Schroders) expects to have a solid year ahead, thanks to a sound economy, an attractive valuation and a positive performance of the renminbi against the US dollar. The onshore market in local currency has become the second largest market in the world (16-17 trillion USR, while the offshore market is larger than the European high yield market). “They are now simply too big to ignore for international investors”.
Both the onshore and offshore markets offer diversification benefits. “The Chinese hard currency credit market is less exposed towards oil and other sectors deeply impacted by the pandemic (tourism), and have therefore showed a good resilience throughout the 2020 crisis”. Over 2020, between 10-30 billions USD have been flowing into the Chinese bond market on a monthly basis, a movement David Cheng expects to continue going forward considering the low exposure of the international investors to this relatively new asset class. “The growth differential will drive flows, and we expect China could catch up the United States by the end of the decade”.
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