Still positive on Hong Kong shares
As Chinese markets are buffeted, we remain positive on Hong Kong shares.
- We retain our overweight position in Chinese equities via exposure to the Hong Kong-based HSCEI or H-shares market, not the mainland Shanghai Composite index. The Hong Kong stock market has been considerably less volatile than those on the mainland, whose erratic moves are driving investor perceptions of all Chinese equities.
- More broadly, we have trimmed our holdings in equities in recent months, in light of the strong performance enjoyed by many markets and the ensuing elevated valuations. While this has been positive as stock markets have fallen, within our equity portfolio we have tended to favour the cheaper valuations available in emerging markets and many of these have fared relatively poorly.
- In addition, we have remained positioned for a rise in longer-term government bond yields through an underweight position in such debt. Government bonds have seen strong demand, however, as investors have sought out ‘safe havens’ of late.
- We remain bullish on Hong Kong equities. We initiated the overweight position in Hong Kong equities in early 2014.
- On valuation, the HSCEI index trades at 8.6x historical earnings, meaning it costs less than £9 to buy £1 of current corporate profits. This compares very favourably with 18x for mainland Chinese equities, 18.7x for the S&P 500 and 21x for European equities. We still see a lot of value in the HSCEI, both on an absolute and a relative basis.
- Our bullish stance has also been based on technical factors. In particular, the launch in November 2014 of an initiative called ‘Shanghai-Hong Kong Connect’ gave global funds much more freedom to invest in Shanghai stocks, and gave mainland investors unprecedented access to shares in Hong Kong. We also saw the willingness of the People’s Bank of China (PBOC) to intervene to curb any slowdown in economic growth, through measures such as reducing reserve requirements for banks, as a significant positive.
- On economics, there is still a widespread perception that Chinese growth continues to be heavily driven by external sources – in particular exports to the developed world. In fact, the contribution to Chinese gross domestic product growth from net exports has been almost zero since the global financial crisis.
- Meanwhile, after having successfully cooled the domestic housing market amid fears of bubble-like behaviour, the PBOC is likely to continue loosening policy to stimulate the economy, via interest rate and reserve requirement ratio (RRR) cuts.
- Economic data over the past month actually paint a positive picture. Growth in GDP was stronger than expected in Q2, with the economy expanding at 7% on an annual basis. Leading indicators such as Purchasing Manager Indices remained in line with trend growth. And while exports and imports fell, much of the weakness in the former can be attributed to the challenges facing Russia and Brazil.
- Furthermore, as a net importer of oil, China is set to gain from lower global commodity prices.
- Much has been said about China’s recent devaluation of its currency by about 4%, and fears of the country exporting deflation to the developed world, the US in particular. Much care should be taken in drawing conclusions here. As background, the Chinese currency makes up only 20% of the US dollar’s trade-weighted index, meaning even a 4% change will have a minor impact on its overall level. Furthermore, the dollar has already appreciated quite significantly – 20-30% in the last year – against the largest two constituents of that index, the yen and euro. A limited depreciation in the renminbi, therefore, will have very little impact on global inflation.
- Last but not least, we see a clear trend in upgrades to estimates for corporate earnings in China, compared with stagnation in the US, albeit at current high levels. Actual reported earnings growth is also on the increase in China, whereas it has plummeted in the US.
- Against this backdrop, we believe the efforts of the Chinese authorities to limit further losses – combined with reasonable domestic economic news, and the discount in Hong Kong-listed Chinese shares versus other markets worldwide – means our overweight position should be rewarded from here.
- And in terms of global markets, it is unclear whether recent declines are simply a correction or the start of something bigger. It could go either way, given the cocktail of bubbling political risk in the word’s trouble spots, weakness in emerging markets and the approach of US interest rate hikes. This raises the prospect that the multi-year bull market in risk assets has reached its end. As such, we maintain a close eye on the situation and are poised to act quickly as developments unfold.
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