Government action indicates positive market momentum for trade-rattled stocks, bonds
The threat of a full-blown trade war with the U.S. is battering Chinese stock and bond prices this year, but targeted moves by Beijing to keep the country's economy on an even keel are giving some money managers confidence to begin hunting for bargains now.
The past month or two has seen the introduction of fiscal measures to ensure adequate financing for infrastructure investments; a relaxation on recently introduced rules to limit wealth management products; regulatory measures to support bank lending; and continued depreciation of the renminbi vs. the dollar.
Against the backdrop of an oversold credit market in China this year, evidence of that policy response kicking in has been "great to see" and is one reason Fidelity International's fixed-income portfolios are looking to add Chinese paper now, said Bryan Collins, a Hong Kong-based portfolio manager and head of Asian fixed income, at a July 24 press briefing in Singapore.
As of June 30, Fidelity's $4 billion Asian High Yield Fund, managed by Mr. Collins, had a 42.5% allocation to Chinese bonds, just under the Bank of America Merrill Lynch Asian Dollar High Yield Corporate Constrained Blended index's 44.84% weighting.
The relative "depth and breadth" of China's policy response helps make the credit of high-quality firms in that country more attractive than that of other emerging markets, Mr. Collins said.
Investors in the mainland's A-shares market make similar arguments. The 18% year-to-date drop in A shares is overdone, and the "extremely nimble" response of China's authorities over the past month or so shows they have "the fiscal and monetary tools at their disposal" to mitigate the impact of U.S. tariffs being levied on Chinese exports, said Pooja Malik, founding partner of San Francisco-based Asian equity boutique Nipun Capital LLC.
Compared to the 4 trillion renminbi ($588 billion) spending package Beijing deployed in response to the global financial crisis a decade ago, "China's government is now seeking to address growth concerns with a chisel instead of a sledgehammer," wrote Tai Hui, J.P. Morgan Asset Management (JPM)'s Hong Kong-based chief market strategist for the Asia-Pacific region.
And increasingly — in addition to the controls offered by a closed capital account and a restricted currency — policymakers can avail themselves of the monetary policy tools taken for granted in major developed economies.
'Relatively brand new'
For China, those tools — a functioning bond market that allows better-quality companies to enjoy a lower cost of funding than weaker companies; an open market operations monetary policy transmission mechanism and a trade-weighted currency basket — are "relatively brand new," Fidelity's Mr. Collins said.
As a package, those "standard" tools have only been operating since late 2015, and so far policymakers employing them on the mainland have passed every test they've faced, he said.
Some of those measures effectively scale back steps that had been put in place in recent years to reverse the sharp run-up in debt, which has fueled the economy's expansion, making China the biggest engine of global growth in recent decades.
That splurge in credit expansion lifted the Chinese economy's debt level to roughly 300% of the country's gross domestic product, up from around 170% at the start of the financial crisis.
Fear that policymakers in Beijing were behind the curve in dealing with that debt burden contributed to a brief but sharp retreat by Chinese capital markets at the start of 2016.
While recent policy moves have de-emphasized "deleveraging" in favor of supporting growth, money managers and consultants said that recent shift has been nuanced rather than wholesale.
"Policymakers have taken their foot off the brake (but) they have not tapped the accelerator," said Aaron Costello, a Beijing-based managing director on Cambridge Associates' global investment research team.
Rather than using "broad and blunt tools" that could set back the goal of reining in leverage, "policymakers have been much more targeted in addressing areas of stress (small regional banks, low-quality corporate bonds, etc.) to avoid unleashing a flood of liquidity," Mr. Costello said. The pursuit of deleveraging has been pushed "down in priority," not eliminated, Fidelity's Mr. Collins agreed. Structural reform aimed at ensuring there's an efficient cost and allocation of capital remains "No. 1" for China, he said.
Increasingly, corporations and state-owned-enterprises that live beyond their means can expect to default, and that's all for the good, Mr. Collins added.
After six years of deleveraging, and amid signs that segments of China's economy were becoming overly constrained, "the return of easing makes me more enthusiastic" about Chinese stocks and bonds, said Robert Samson, a Singapore-based managing director with Nikko Asset Management Asia and senior portfolio manager on the firm's global multiasset absolute-return team.
Some loosening is needed, occasionally, to ensure the kind of growth that can support continued reforms, said Mr. Samson, calling the process a "balancing act."
Economists concede moves to relax Beijing's recent vigilance when it comes to controlling credit expansion could revive fears about the country's debt burden.
"The worries about China's debt vulnerabilities are real," but the question is how likely is a crisis, said Chi Lo, Hong Kong-based senior economist, Greater China, with BNP Paribas Asset Management.
"My view is that it is not likely," he said, noting that — compared with the previous flare-up of those concerns in late 2015 and early 2016 — "today's economic and corporate fundamentals are better, corporate profitability is stronger, foreign exchange reserves are higher, macroeconomic policy coordination is better and structural reform and debt-reduction drives are stronger."
That debate will continue to spur market volatility from time to time but those investors who bet on systemic collapse, like some hedge funds did a few years ago, will not profit, Mr. Lo predicted.