As published in BlackRock’s 2018 global market outlook, our view on China market is that the equity bull run is going to stay despite a mild economic slowdown, while there will be higher volatility and less room for upside surprises.
The seeming misalignment between the perspectives of the macro market and equity market can be explained through our analysis of key risk factors in 2018.
In our view, the three biggest, high-odd risks to China’s equity market are:
1. Profit-taking of global tech stocks to impact the performance of China ADRs.
2. Policy-tightening measures in the domestic property market, financial deleveraging and infrastructure investment to trigger GDP growth slowdown.
3. US interest rate hikes exceeding expectations and the strong US dollar to drive capital outflows from emerging market (EM) equities.
Regarding tech stocks, the US tax reform has already led to a mild sell-off in December 2017. Should we see other risk events such as an unexpected weakening of smartphone sales or a bitcoin bubble burst, a broader sell-off of global tech stocks is likely to be triggered. This is not our central scenario but we are closely monitoring this risk factor given China tech ADRs and Hong Kong tech stocks make up 25-30 percent of the MSCI China index.
While China’s policy-tightening measures are driven by proactive reforms rather than reactive market response, an economic slowdown is very likely to take place. Domestic and overseas economic conditions are currently healthy, presenting great opportunity to push forward reforms at the cost of slower GDP growth in the short term.
But there is plenty of room for policy adjustment. If the reforms reach initial targets or financial stability is threatened, we believe the government will scale back some tightening measures accordingly. For example, the government may relax the quota on environment-friendly industrial capacity after cleaning up most of the overcapacities, or adjust the pace of financial deleveraging based on market response to higher interest rates.
As for the risk of capital outflows from EM equities, we believe the impact on Chinese equities will be relatively small. We don’t think US rate hikes in the coming year and the implementation of tax reform are going to reverse the trend of global capital flows.
According to EPFR, emerging markets have experienced a total of US$115 billion capital outflows for four consecutive years (2013-2016). The trend has reversed in 2017 but with only US$65 billion inflow.
Under the current backdrop of synchronized global economic growth, investors around the world are pursuing high-growth opportunities, and moving into EM equities is one option to capture growth opportunities.
We don’t think US rate hikes or the strengthening of the US dollar will reverse this macro capital flow trend. Specifically for H shares, RMB/USD is range-bounding rather than undergoing unilateral devaluation like two years ago. Coupled with the continuous southbound inflow from the Stock Connect scheme, we are not very concerned about the capital outflow associated with US dollar appreciation.
In summary, we should stay alert in case of a massive tech sell-off; market correction caused by China’s domestic policy tightening, which is beneficial to the quality of long-term economic growth, will potentially pose buying opportunities; and market volatilities due to US rate hikes tend to be short-lived.
We stay convinced of a bull market for Chinese equities in 2018, albeit less smooth-sailing as in 2017. We expect to see sector rotation – the heydays for property, certain auto and tech stocks may be gone. We are bullish on financials, as well as selective advanced manufacturing and consumer services stocks that are undervalued at the moment.
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