17 February 2019
Exchange rate uncertainties have added to the challenges for investors in Chinese stocks. Photo: CNSA
Exchange rate uncertainties have added to the challenges for investors in Chinese stocks. Photo: CNSA

Ten challenges and opportunities in 2016

Following a rocky start for the markets in 2016, let me outline ten things that we need to bear in mind this year.

1. Sell A-shares at every peak

The Shenzhen-Hong Kong Stock Connect is likely to be launched in the first half of this year. That would increase the odds of A-shares inclusion into the MSCI index in the second half. If so, that will give a boost to China stocks in the last quarter.

In the near term, Chinese stocks could face liquidity pressure ahead of the Chinese New Year. So investors should use any market rally to reduce their holdings. Stocks may pick up only after the long holiday next month.

2. Market differentiation

Emerging economies and some developed nations rely on resources exports which are closely linked to China. Taiwan, South Korea and other manufacturing economies are likely to perform better thanks to currency depreciation and recovering US demand. Investors have to differentiate between markets which have varied degree of dependence on China demand.

3. Economic recovery

Market confidence will be restored if US recovery is well on track. China market may become attractive again for foreign investors after Beijing’s financial reforms and market rescue measures.

4. Mutual Fund redemptions

China’s stock rout on January 4 has highlighted the redemption issue for southbound funds that are subject to the nation’s circuit breaker mechanism. Investors should keep themselves informed about any redemption halts.

5. US dollar uncertainty

Most institutional investors expect the Fed to hike its key rate three to five times this year, which would further strengthen the US dollar. However, the world’s largest economy won’t be immune from the problems in the rest of the world. Given the risks, the Fed tightening will be measured and gradual.

If there is growing risk of deflation, investors should go for bonds or cash. There is a volatility that the US dollar rally will run out of steam.

6. Chinese yuan

China’s currency has tumbled the most in two decades at the end of last year, as the annual deposit rate has come down to 3 percent from a double-digit figure in the past. Investors are scrambling to park their savings overseas for fear of further yuan depreciation.

However, huge amounts of capital will flow back into China if Beijing succeeds in financial market reforms. If reforms gather pace, the yuan will stabilize and even post an uptick. China’s bond market is worth US$8 trillion, making it the world’s third-largest. But foreign investors account for only 2 percent of the market. There is huge growth potential if the ratio increases to 10 percent.

7. US presidential race

If Hillary Clinton wins the US presidential election, she will target rising drug costs. The pharma and bio-tech sectors have already faced some heat last year. Both sectors could see further downside if Clinton wins the top job. A slide in the stocks will, however, offer a buying opportunity for long-term investors.

8. Short-selling

What is the best asset class this year? Cash? Bonds? Equities? Commodities? Real estate? I believe the best strategy for the first quarter is short-selling. The Hang Seng Index has tumbled more than 1,000 points within a few days.

9. Financial stocks

Financial stocks are the cheapest in US and European markets. The NYSE Financial Index has an average P/E multiple of 15, and European financial stocks only have P/E ratio of around 12, compared with 40-year average of 21. There is huge upside in the long run. However, the stocks may fall sharply if the US economy fails to normalize.

10. Geopolitical risks

Republican presidential front-runner Donald Trump has called for Muslims to be barred temporarily from entering the US. Such radical rhetoric may encourage some people to join jihadist groups such as Islamic State.

Meanwhile, Saudi Arabia’s decision to execute a prominent Shiite cleric has sparked a diplomatic and trade row with Iran and left many concerned over destabilization across the Middle East.

Risks emanating from the Middle East could spill across the world.

This article appeared in the Hong Kong Economic Journal on Jan. 7.

Translation by Julie Zhu

[Chinese version 中文版]

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Founder and Managing Director of Pegasus Fund Managers Ltd.

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