06.03 - Has China become an opportunity for investors?
With a contribution from Adrian Zuercher
Global emerging market funds are currently more negative on China than at any point over the past 15 years. Data from EPFR and Morgan Stanley show funds holding 5% less in China than the country's weighting in the MSCI Emerging Market Index. That compares to an underweight of around 1.5% just four years ago. The UBS Chief Investment Office (CIO) believes this pessimism is overdone.
Over recent years, markets have focused largely on the risks of an economic or financial accident in the country, arising from surging debt levels, an overheating housing market, and heavy capital outflows. While such concerns are real and need to be monitored in 2017, the outlook has brightened. China is an instigator and prime beneficiary of the global reflation trend. The drag on corporate profits from factory gate deflation has ended. Producer prices, which were declining at a year on year rate of 5.9% as recently as December 2015, were rising at 6.9% in January this year. This reflects a reduction in overcapacity in Chinese industry, along with higher commodity prices, and improves the outlook for Chinese firms.
Worries over non-performing loans should also ease. The bad debt ratio of Chinese banks climbed to 1.81% by the end of 2016, the highest since the second quarter of 2009, according to data from the China Banking Regulatory Commission. Still, rising profits combined with falling real interest rates should profit relief to corporate borrowers.
In terms of valuation, China trades at attractive levels compared to peers and offers a significant discount to developed markets, with a roughly 20% discount to the MSCI World Index. And returning to market positioning, the heavy underweight positions of global emerging market funds suggests that there will be plenty of potential buyers if sentiment on China turns.
CIO is overweight China in our Asia Pacific tactical asset allocation.
