For investors allocating assets internationally, it's important to stay focused on secular growth trends in China and avoid getting caught up in fears that could lead to missing out on potential long-term gains. Indeed, Chinese stocks could well rally before the end of the year.
Air travel provides an apt metaphor for what we have observed in China. Turbulence caught investors by surprise this summer — turbulence of the kind that leads to the familiar announcement, “Ladies and gentlemen, the captain has turned on the seat belt sign.”
Although turbulence is uncomfortable, it's usually not dangerous. The pilots may have to make adjustments, but the plane keeps flying in the right direction.
Equity markets have more than discounted the risk that turbulence will force a hard landing for the Chinese economy. Therefore, we are taking the opportunity to gradually increase our exposure to China, both through equities that we believe have more than priced in this near-term risk and defensive convertibles that appear well-positioned to participate in the eventual recovery of the Chinese equity markets.
Capital preservation remains paramount in the current environment. Nonetheless, we are seeing encouraging signs that can improve investor sentiment about China by alleviating concerns about an imminent hard landing.
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China's government has a variety of tools to prevent a sharp deceleration in growth. Over recent months, we've seen monetary policy become more accommodative and the announcement of additional infrastructure stimulus, as well as fiscal stimulus meant to support the housing and auto industries. While we do not expect these to spark a growth re-acceleration, they could contribute to a stream of stabilizing data.
EXPECT SIGNS OF STIMULUS
China's primary measure of manufacturing activity, the purchasing managers' index, or PMI, was 49.8 for September. While still hovering below an expansionary level of 50, the reading showed signs of stabilizing and came in ahead of the consensus estimate of 49.7. Moreover, we were expecting muted manufacturing data in September as a result of the massive manufacturing shutdown mandated by the government to ensure blue skies for China's commemoration of the 70th anniversary of the end of World War II. Our view has been that once the “Victory Blue” shutdown concluded, we would begin to see signs of recent stimulus working through to economic data. State-owned enterprises are likely to show the benefits of stimulus first, with a trickle down to small and medium enterprises in the coming months.
We've also seen a stabilization of the renminbi after a sharp depreciation, with additional capital controls being implemented to manage the flow of capital and reduce the volatility in the exchange rate. Over the medium term, we should expect further depreciation in the renminbi relative to the dollar as the currency adjusts to the weakness of other major currencies, such as the euro and yen, but the rate of the depreciation will be important as companies and governments adjust to this new environment.
In addition, we don't think China's decision to “reform” the renminbi signals its intention to exacerbate a global currency war. It appears China is attempting to quell market concerns by supporting current levels, at least until the International Monetary Fund decided whether to include the currency within its special drawing rights reserve, which it did last Monday.
In this environment, we maintain a focus on Chinese companies positioned to benefit from secular growth opportunities, which has led to heavier weights in technology and consumer sectors. We also see opportunities in industrials and financials that we expect to benefit from financial reforms and infrastructure investments.
China represents too big an opportunity to ignore.
Nick Niziolek is co-chief investment officer, head of international and global strategies, and senior co-portfolio manager at Calamos Investments.