It’s been a good run for China’s A-shares, the best performing emerging market asset class this year. But mainland China stocks are getting tired. Investors are cashing out.
“Profit-taking ruled the day despite Friday’s strong credit data and positive weekend trade comments from Treasury Secretary Steven Mnuchin,” says Brendan Ahern, CIO of KraneShares, a long China ETF company.
Market momentum seems to have been lost for now.
Chinese brokers in Hong Kong said investors are cashing in after 40% gains in the A-shares market year-to-date. There is some concern that the recent “green shoots” in the Chinese economy, with the IMF raising its growth outlook to 6.3% from 6.2% for the year, could slow more stimulus and easy money. That, plus a stalled out trade war have been the story of the year for emerging market fund managers. China investments have paid off nicely.
The People’s Bank of China recently reaffirmed its aversion to Great Recession-era stimulus, something both Xi Jinping and his economic frontman Li Keqiang have come out against all year. The market largely was not buying it and made the right call as China did indeed flood the zone with new loans.
Credit flows show that there was an additional three trillion renminbi pumped into the market compared to the same period in 2018. Most were concentrated in bank lending and local bond issuance. China’s local bond market was just included in the Bloomberg Barclays Global Aggregate Bond Index, though that is primarily Chinese Treasury debt and not municipal or renminbi-denominated corporate bonds.
Local bond issuance in the first quarter was 1.4 trillion RMB, at least a trillion RMB more than the first quarter of last year. Meaning, with regards to the PBoC’s rhetoric on credit…someone somewhere in the provinces is not listening to them.
There is no explicit announcement of bank lending quotas, but Keqiang said during the “Two Sessions” meetings back in March that he wanted government banks to lend more money to small and mid-sized businesses. That seems to have happened even before he made that announcement.
Strong rhetorical commitments against credit stimulus suggests that increased bank lending year-to-date was the result of aggressive front-loading rather than a sharp increase in annual loan quotes. So there is a chance that the loan market slows, credit slows, and China’s economy — while doing well — has peaked.
The market may be taking a breather, with sideways trading action expected over the next two weeks May ahead of MSCI’s new weighting of A-share equity in its China indexes.
“We are going to move our portfolio based on valuation,” says Andrew Miller, CIO for emerging market equity at Mondrian Investment Partners.
Mondrian owns companies that are less impacted by tariffs and less reliant on credit stimulus to grow. They own the Hong Kong-listed shares of Ping An Insurance, food giant WH Group, owners of Smithfield Foods in the U.S., and the Shenzhen listed shares of Midea Group, a home appliances company making air conditioning units. “We thought they were way oversold when everyone hated China last year and we bought it.” The stock is up 30% in the last three months and 39% year-to-date in the local currency.
Meanwhile, on Beijing’s non-stimulus stimulus plan, it’s property market is going to get a boost as provincial leaders are giving up on purchase restrictions.
Xi Jinping once said that “houses are for living in, not speculation.” But local leaders are not seeing it that way.
“Either the deleveraging policy is credible, in which case we should expect any credit stimulus to be unwound as soon as it gains traction, or the economic agenda of the all-powerful leader will be exposed as unworkable,” says Brian McCarthy, a former hedge fund manager now chief strategist for MacroLens, a big picture investment research firm focused on China.
If China’s real estate market is let loose, it could limit downside risks to one of China’s most important economic sectors. Ivy Investments economists led by David Hamilton think that if that happens, coupled with already loose monetary and fiscal policies and the potential for a trade deal with the U.S. China see better growth than expected.
Teresa Barger, CEO of Cartica Management, has just one A-share in its emerging market portfolio of roughly 25 long-only stocks. The trade war may be on hold, but it could pull the rug out from China investors quickly. “We can have a religious debate over who needs a trade deal more, Trump or Xi,” she says of Chinese leader Xi Jinping. “It is probably unanswerable by us mere mortals.”