The latest trade data from China has revealed a 3.1% fall in exports and 0.7% decline in imports in June compared to a year earlier. This has spooked Asian markets and reinforced concerns about the pace of the slowdown in Chinese growth. This comes on the back of official data showing that inflation rose to 2.7% in June, up from 2.1% last month.
While we are long-term emerging market bulls at Bestinvest, we have been cautious on China for some time. China has been the engine of world growth for several years but its rapid expansion, which has been heavily reliant on exports and internal investment, has created serious imbalances that need to be addressed in order to achieve a more sustainable rate of growth that recalibrates towards domestic consumption. We have also been highlighting our concerns over the growth of China’s shadow banking system, which has some of the characteristics of a Ponzi scheme.*
The transition of China’s economy is likely to be a painful one over the short to medium term for emerging markets but also commodities as China has been such an important driver of raw material prices. For this reason, we are underweight commodities in managed portfolios and favour emerging market and Asian funds that are currently positioned underweight China, such as First State Global Emerging Market Leaders, but with the mandate that can increase exposure when the manager feels appropriate. An alternative is to hold funds that can use derivatives to manage downside risk, such as the Asian Total Return Investment Company plc, an investment trust recently handed over to Schroders.
China v Japan? It all depends on your time horizon...
While China remains a compelling long-term story should wealth and consumption spread out to its huge population, over the shorter to medium term the better opportunities may well be with China’s traditional Asian arch-rival Japan despite its poor long-term demographic profile. Many private investors have little or no exposure to Japan, despite it being the second largest stock market globally, having lost faith with Japan years ago.
All eyes East on 21 July
However, the shock and awe reforms implemented in Japan in first half of this year by the Coalition elected at the end of 2012 appear to be working so far, with strong GDP growth, rising exports and improving consumer confidence. A strong showing by the Liberal Democrat Party of Prime Minister Shinzo Abe in the Upper House Elections on 21 July could result in a commanding majority for the LDP enabling Abe to accelerate the pace of reform. We will be watching the results closely. Funds we like are GLG Japan Core Alpha (large cap value), JO Hambro CM Japan (multi-cap) and CF Morant Wright Nippon Yield (small cap value).
An alternative strategy is invest through a pan-Asian fund which can allocate to Japan and the rest of the region. These are few and far between these days but our top choice is Aberdeen Asia Pacific & Japan, which currently has 22% allocated to Japan and just 3.9% in China.
* Read ‘The changing nature of Chinese economic expansion’ from Bestinvest’s Chief Investment Officer Gareth Lewis here