Jason Hollands, Tilney Bestinvest Managing Director, Business Development and Communications comments.
A week ago it was volatility in Gold prices that dominated the market news headlines, but this week attention has firmly switched back to the rout in Chinese equities that began in June, which we believe is a much more significant market development. In particular Monday saw a massive decline of 8.5% in the value of the Shanghai Composite Index one of the steepest one-day declines on record.
The slide in the value of China's mainland stock markets - the Shanghai and Shenzhen exchanges - has been unfurling with a vengeance since mid-June. In our view it represents the abrupt bursting of a bubble after an unsustainably steep rise that began in earnest in July 2014 pushing share valuations too high, too quickly. Indeed the Shanghai Composite Index rose by approximately 150% from July last year to its peak in mid-June and that does not include dividends.
This extraordinary boom appears to have been fuelled by attempts by the Chinese authorities to clamp down on credit financed property development, which resulted in Chinese investors switching their attention to the stock markets. When you squeeze a balloon in one place, the air simply moves elsewhere. Unlike most developed stock markets, where shares are largely in the hands of institutional investors, including pension and insurance funds, around 90 million Chinese private investors are believed to own around 80% of the local markets.
The situation unravelling now has been exacerbated by the large numbers of Chinese investors who have been able to access so-called "margin trading" accounts, where they have been able to invest in shares while only putting down a fraction of the amount of their position, essentially meaning small investors have been able to borrow money from brokers to invest in shares. As markets have fallen, investors facing a wipe-out have been panic selling to try and staunch the scale of their losses, which have been magnified by their borrowings.
The sense of panic has been compounded by thus far fruitless attempts to arrest the slide. For a one-party State where the controlling presence of the "authorities" is deeply embedded, this has increasingly given the impression of desperation.
Chinese authorities have tried measures including a surprise cut interest rates, a temporary suspension on the opening of new margin accounts and dragooning brokerages and fund managers to buy shares to bolster prices. The authorities have also vowed to hunt down and punish speculators they claim are driving down the markets and have curbed planned Initial Public Offerings.
Additionally, over half the companies on these markets have suspended trading in their shares to prevent selling, in many cases at the request of companies themselves, raising the concern that they may have borrowed money against their equity.”
What does this mean for UK investors owning Asia funds?
It is important to understand that the exchanges at the epicentre of the turmoil, Shanghai and Shenzen, have restrictions on foreign investors (although China has been taking some steps to open these markets up). This means most Asian and Emerging Markets funds available to UK investors have little if any direct exposure to these exchanges. Their China holdings are typically held through mainland companies that are traded on the Hong Kong stock market, whose investors are more international and institutional in profile. However, the current volatility has clearly dented overall sentiment towards China, Asia and broader emerging markets and so there has been some spill over though with far less brutality.
For the long-term investors China clearly offers potentially significant attractions. It has a vast and young population and has already grown to become the world's second largest economy. As affluence spreads and the growing Chinese middle class want goods and services we take for granted in the developed world, there are undoubtedly considerable opportunities.
However, in the near term China faces major economic challenges. Our investment team have been consistently very cautious in their view of China in recent years, in the belief that China's economic model has become fragile and unbalanced, with too much reliance on internal investment and exports, and a need to adjust to a lower but more sustainable level of growth. Although official GDP growth data suggests a target rate of 7%, still much higher than the levels seen in the west, the real rate of growth could be much lower at around 4%. In our Multi-Asset Portfolios, we have been underweight exposure to Asian and Emerging Markets reflecting our cautious stance.
In summary, the recent bout in Chinese stock market volatility merely reaffirms our existing cautious view because there may be knock-on effects that are difficult to quantify at this point but which might feed through to both sentiment and the real economy in a negative way. For example, what impact could there be on the Chinese economy as a result of investors nursing stock market losses reducing their spending and from steps to rein back on excessive lending?
The level of interconnectedness between Chinese markets and elsewhere is largely unknown. But there is clearly scope for losses made by Chinese investors, to have an impact on superficially unrelated asset markets elsewhere. Affluent Chinese have been investors in assets internationally - from stock markets to the London property market. No one really knows what the spill-over impact could be and the extent to which some may need to dump these assets to meet losses made domestically is unknown. Time will tell as to what impact, if any, this might have on global markets and growth rates.”
A cautious approach
While it can often make sense to buy when others are selling, it is nigh impossible to predict with any accuracy when a market has peaked or reached a floor. In view of continuing uncertainties facing China, we believe it is right to retain a cautious approach and remain underweight the region in our Multi-Asset Portfolios.
For investors who make their own decisions we believe that the most appropriate way to achieve exposure to China is through broader Asia ex Japan funds or Global Emerging Markets, where managers can adjust exposure over time, rather than through investments with a narrow focus on China. Our Premier Selection does not include any funds in the Investment Association China / Greater China sector. Our top rated Asian ex Japan and Global Emerging Market funds include First State Asia Pacific Leaders and Fidelity Emerging Markets.”