China Is Making Investor Calls So Awkward
Don’t ever underestimate China’s ability to shock and awe.
Just when global asset managers had given up for good, Beijing made an abrupt turn, rolling out a barrage of stimulus measures before going on a week long national holiday. While lacking in operational details, the change in official rhetoric and the “big guns” they’re bringing out prompted billionaire investor David Tepper to declare his desire to buy more of “everything” related to China.
Unfortunately, most chief investment officers don’t have Tepper’s swagger. They manage other people’s money and need to justify their asset allocations. Having already missed the initial stage of the rally, they need to come up with a coherent argument to defend their positioning on China.
As of early September, shorting China — and being bullish on US big tech — were the two most crowded trades, according to the latest Bank of America global fund managers survey. One-third of those polled were already looking elsewhere, running emerging markets funds without exposure to China.
But the tables are turning. After an explosive rally, the benchmark MSCI China Index has caught up with the S&P 500 Index, gaining around 30% for the year. So it’s not hard to imagine clients asking their money mangers how much exposure they already had on China, and whether it was time to accumulate, especially since the US market appears to have lost its momentum.
Chinese equities are still not expensive despite the recent melt-up. People have compared this economic policy pivot to Beijing’s exit from Covid Zero in late 2022, finding similarities in their abrupt and sharp turn. If we are referencing that time, the MSCI China index traded at as much as 11.8 times 12-month forward earnings in early 2023. We are at 11.4 times now. In other words, market optimism is just about par with the 2023 reopening trade, when investors had hoped that the end of lockdown would unleash pent-up consumer demand, but well short of the euphoria seen in earlier years.
What we have witnessed over the last four years was a steady de-rating of Chinese equities. Regulatory crackdowns on big tech, as well as a deep property downturn, have transformed China from a growth market well-loved by foreigners into a value trap. At its early 2021 peak, MSCI China traded at close to 19 times forward earnings, about a 15% discount to the S&P’s valuation. Now, the valuation discount has widened to almost half.
So the big question that CIOs must address is whether a supercharged stimulus package, as well as an official reversal in attitudes toward big consumer tech, might create a paradigm shift in Chinese equities again. If a re-rating occurs, it’s not too late to build up positions.
Unfortunately, by taking their eyes off China, many are no longer equipped to answer that. By the time they figure out what prompted President Xi Jinping’s change of heart — an essential point in that it determines whether this is Beijing’s “whatever-it-takes” moment — as well as how much stimulus domestic investors are expecting, the market would have moved beyond their recognition.
Of course, an easy way out is to ask whether China is investable, given the unpredictable nature of Beijing’s policymaking. Lombard Odier’s CIO Michael Strobaek, for one, has dumped all his exposure and said he was moving into other emerging markets.
But this strategy runs the risk of glaring underperformance, as well as investor ire and skepticism, as to whether one can really have no exposure to the world's second-largest economy. Southeast Asia, for instance, has risen to become Beijing’s top trading partner. China Inc. is made up of big investors in the fast-growing Global South, setting up manufacturing facilities from Brazil to Indonesia.
China is a good place to test a money manager’s insight, conviction and research capabilities. Its government has a proven track record of hitting a wall, bleeding, turning around and somehow staging a comeback. So the key is to discern whether this is a pivotal moment for the Communist Party or just another dead cat bounce. Either way, emerging markets investing is risky business, and one simply can’t spot the next China if she doesn’t know China.
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