Chinese stocks face their greatest challenge since the global financial crisis, according to one fund manager in the region.
“I have been managing money for eight years, and in that time I have always said how China is a great investment opportunity. Today, I have to start my presentations with the challenges, because there are some big risks out there,” admits Raymond Ma, portfolio manager at Fidelity.
Ma cites China’s key challenges as a depreciating renminbi, high leverage level and the pain of deleveraging, and weakening consumption growth, but the biggest risk to returns? The trade war with the United States.
Currently $50 billion worth of imports from China are subject to 25% tariffs, but reports this week suggest the US is drawing up plans to tax the remaining $257 billion of Chinese goods that land on US shores every year. The Shanghai Composite is down 21% year to date as a result of the tensions.
Speaking in Hong Kong on Tuesday, Ma stressed that is was not all bad news for investors in Chinese equities – there were certain areas of the stock market which could still deliver returns throughout a trade war, as proved in Japan three decades ago.
Looking for an example in history where a stock market faced similar challenges to the headwinds China stocks are currently enduring, Ma drew comparisons with the trade frictions between Japan and the US in the 1980s.
At the time, it was said Japan – the then emerging power of Asia – had taken jobs from US citizens, in particular, Detroit-based factory workers. Their cheap currency and wages attracted global players away from the US. Such was the upset one American politician threatened to “fix” the Japanese, while another joked that the US should have been more aggressive in their nuclear offensive during World War II.
Instead, the US put tariffs on Japan’s electronics, technology, automotive, steel, lumber and sugar industries, squeezing the Japanese economy and forcing the government to eventually sign the 1985 Plaza Accord, pushing up the value of the yen.
“Japan’s challenges were severe,” says Ma. “GDP growth came down, as did their trade balance. But if we look at the index, it actually increased as the Japanese government reacted to the trade war by loosening domestic policy.”
Comparisons can be made with China here too – the People’s Bank of China has eased monetary policy over the summer in response to Trump’s tariffs.
The Japanese rally wasn’t to last however. In 1990, the bubble burst, causing the stock market to tumble.
Ma is not definitive as to whether the 20-30% pull back in Chinese equities this year is a temporary blip before a rally as PBOC stimulus trickles through to stocks, or China’s equity bubble bursting as Japan’s did.
“Where are we the cycle when comparing China to Japan? I am not sure,” admits Ma. “We are certainly not at the peak that I know.”
What Next for China Equities?
Instead of trying to guess where the market as a whole is moving, Ma examined which Japanese equities did well in the downturn. He found that from 1990 to 1994, the Topix tumbled, but there were still select stock examples which rallied. Those in consumer related industries, and IT, delivered impressive returns, while stocks linked to the old economy, such as financials, failed.
“It gave me confidence that if I focused on stock picking, all will be well,” he said.
Ma says the Chinese modern equivalent of those contrarian Japanese companies can be found in automation; robotics and cars, retail firms which utilise big data, cloud storage, e-commerce, electric vehicles and artificial intelligence.
But anyone familiar with Japan’s economic and stock market progress since the trade war era may well point out that it is not a path China would want to follow.
Ma acknowledges the challenges Japan has faced, but says China will be saved from a similar deflationary fate by its best resource – a cheap educated workforce.
“China has 16 million 18 year olds, every year, and half of them go into blue collar labour. That is eight million engineers, which cost 25% what an engineer does in the US. As long as there are enough industries to accommodate them productivity in China will rise. Japan did not have that,” he says.
“It is also worth noting that Beijing policy makers have been studying the Japanese example for years.”
