All in the price in China?
It’s been a while since Chinese stocks earned investors fat profits. Last year the Shanghai market lost 22 percent and the compounded return on equity investments there since 1993 is minus 3 percent. This year too China has underwhelmed, rising less than 3 percent so far. Broader emerging equities on the other hand have just concluded their best first quarter since 1992, with gains of over 13 percent.
Given all that, bears remain a surprisingly rare breed in China. A Bank of America/Merrill Lynch’s monthly survey found it was fund managers’ biggest emerging markets overweight in March and that has been the case for some months now. Clearly, hope dies last.
Driving many of these allocations is valuation. China’s equity market has always tended to trade at a premium to emerging markets but in recent months it has swung into a discount, trading at 9.2 times forward earnings or 10 percent below broader emerging markets. MSCI’s China index is also trading almost 25 percent below its own long-term average, according to this graphic from my colleague Scott Barber (@scottybarber):
There are reasons for the cheapness of course. The economy is slowing and looks on track for its weakest quarter since 2009. Recent corporate earnings have disappointed and there are worries over local government debt and bad loans at banks. The property sector remains a worry and it is unclear if the PBOC will ease monetary policy. But many reckon the problems are in the price.
JPMorgan Asset Management for instance has changed its historic bias against Chinese stocks in its EM fund. China is now the fund’s biggest overweight, more than 5 percent above the MSCI benchmark. Client portfolio manager Emily Whiting expects the market to rebound strongly once investors start unwinding their doomsday bets:
Historically China has been an underweight for us as we always felt the valuations too rich against the broader emerging markets opportunity set.. Now it is our largest overweight country position, we feel the market has priced in too much bad news and it’s created buying opportunities…. it’s a great environment for stock pickers.
Emerging Markets: the love story
It is Valentine’s day and emerging markets are certainly feeling the love. Bank of America/Merrill Lynch‘s monthly investor survey shows a ‘stunning’ rise in allocations to emerging markets in February. Forty-four percent of asset allocators are now overweight emerging market equities this month, up from 20 percent in January — the second biggest monthly jump in the past 12 years. Emerging markets are once again investors’ favourite asset class.
Looking ahead, 36 percent of respondents said they would like to overweight emerging markets more than any other region, with investors saying they would underweight all other regions, including the United States. Meanwhile investor faith in China has rebounded with only 2 percent of investors believing the Chinese economy will weaken over the next year, down from 23 percent in January. China also regained its crown of most favoured emerging market in February.
Last year, the main EM index plummeted more than 20 percent as emerging assets fell from favour. So what is the reason for this renewed passion in 2012?
Firstly December’s LTRO — a multi-billion euro liquidity arrow from the cupids at the ECB has revived investor appetite for riskier emerging assets, boosting the index to around six-month highs since the start of the January. A second significant factor behind the resurgence in risk sentiment is that the market is daring once again to hope for an improvement in global growth, says Gary Baker, BofAML Global Research head of European equities strategy.
The big beneficiaries of all this have been emerging markets. It’s not just about liquidity. Clearly the actions of the ECB have been vitally important… but what you’ve also seen is an improvement in global growth optimism. If optimism over growth is improving then there may well be a more fundamental underpinning to the movement.
So is investors’ new-found love for emerging assets a passing flight of fancy or a true sign of commitment?
The significant monthly improvement in market sentiment towards emerging markets and the 44 percent level of investors overweight emerging markets are both events which have historically coincided with short-term underperformance by emerging equities, Baker says.
What fund managers think
Bank of America-Merrill Lynch’s monthly poll of around 200 fund managers had a few nuggets in the June version, aside from the usual mood-taking.
Gold is too expensive. A net 27 percent of respondent thought it overvalued, up from 13 percent in May. Then again, the respondents to this poll have reckoned gold is too pricey since September 2009.
The fall in the euro should be tailing off. A net 14 percent reckon the single currency is still overvalued, but that is way down from the net 45 percent who thought so in the May poll.
BP is good for pharma. The net percentage of fund managers who remain overweight in energy stocks plunged to 7 percent in June from 37 percent in May as oil has continued to spill into the Gulf of Mexico. The stock beneficiaries have been “dividend friendly” utilities, telecoms and pharmaceuticals.
China’s growth is slowing. A net 27 percent of investors reckoned China’s economy will weaken from where it is now over the next 12 months. That probably has mixed blessings given that investors both are expecting China to pull the world along the course of recovery and are worried about its economy overheating.
Overall, the poll showed fund managers to be cautious about the world economy but not giving up on riskier assets.
Another fine excuse for selling stocks
There is no question that the losses on stock markets at the moment are primarily the result of the Greek crisis. A downgrade of a euro zone country’s sovereign debt to junk is enough to make all but insane mainstream investors take a large step away from risk.
But could it also be that the Greek crisis has come at a time when big investors were looking for an excuse to cool down the equity rally? MSCI’s all-country world stock index hit a peak on April 15 that was not only higher than anything seen this year, but also last year as well. Up about 85 percent from its March 2009 lows, in fact.
Partly as a result, there were some signs emerging that suggested a correction would soon be in the works.
– Morgan Stanley noted that one of the indexes it follows had been up at least 50 percent year-on-year eight times in March. History showed that on 77 percent of such occasions that equity markets had subsequently fallen 4 percent.
– Bank of America Merrill Lynch’s April fund manager survey saw cash holdings had dropped to 3.5 percent of assets. On four out of five occasions that that has happened before, BofA said, equities declined by 7 percent in the following 4-5 weeks.
Now comes a new sign. State Street’s investor confidence index dropped below 100 this month, the first time it was in risk averse territory for more than a year. It was only a small drop, but significantly it was the first time since March 2009 that it has been below 100.
So, yes, Greece is pummeling markets and putting the frights into in global investors. But the market could well have been ripe for it anyway.
