27th August, 2015
Hugh Young, managing director of Asian equities at Aberdeen, shares his thoughts on China
In recent years, emerging markets have looked vulnerable at times, but not to the extent we have seen over the last couple of weeks. So what’s going on? To my mind, investors are mainly concerned about China. What’s changed has been their confidence in the ability of Chinese policymakers to manage the slowdown that has sapped global demand.
A-share market bubble bursts
That confidence was first shaken when the stock market bubble burst. This should have come as no surprise, since most yuan-denominated shares traded in Shenzhen and Shanghai do a poor job of reflecting corporate earnings. Rather, they are a reflection of the messy interaction between government market manipulation and the on-off speculative appetite of China’s retail investors.
However, investors were convinced policymakers would do whatever it took to support the so-called A-share market. What we’ve witnessed instead are a series of heavy-handed policy moves, each one more impotent than the last. It now seems Beijing has all but given up.
Next came the shock of a yuan devaluation. Depending on your point of view, this was either a positive sign that China remains committed to the goal of currency liberalisation, or a desperate attempt to boost flagging exports.
Whatever the intention of Chinese policymakers, Asia is feeling the effects. Growth is sluggish and businesses are struggling to lift earnings. Central banks across the region may be tempted to follow Beijing and weaken their own currencies in an attempt to maintain export competitiveness.
Asia’s vulnerability is particularly bad news given the fragility exhibited elsewhere, especially within the developed markets - Greece always seems one loan away from being kicked out of the Eurozone, while stimulus policies in Japan have not translated into sustainable growth.
With the Federal Reserve all but having committed to an interest rate rise soon, this will put unwanted pressure on the US central bank in the shape of a rising dollar and downward pressure on prices.
Should investors be worried?
In the face of all this, investors are right to be worried. Prices have been supported by liquidity and confidence in policymakers’ judgement, not by business fundamentals.
On the other hand, we feel reasonably comfortable, and even vindicated, by the recent sell-off. If prices start to reflect fundamentals more closely there will be opportunities.
Asia, and more so emerging markets, looks cheap compared with Europe and the US. It seems perverse that money is flowing away from the developing world, especially when you realise that corporate earnings there have stabilised for the most part (if you exclude the commodity companies). We may even see an earnings recovery as soon as next year.
Rising risk aversion is in part driven by currency weakness, but this is as much a reflection of a strong dollar as an indicator of potential problems at home. Our view, therefore, is that currencies may exaggerate market weakness in the short term, but they do not play a significant part in equity performance in the long run.
We should add that the present situation is nothing like the dotcom crash, Sars, or most recently the global financial crisis. One or two countries are, without question, vulnerable to capital outflows, which will put pressure on debt servicing and currencies. But these are the exceptions and we do not see scope for contagion because the differences within emerging markets are better understood today. Comparisons being made with the Asian crisis nearly 20 years ago make no sense to us.
So we continue to have great confidence in the quality of our stock selections, as well as the long term story that underpins Asia. Our experience suggests that none of what’s happening is particularly new or surprising.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Hugh's views are his own and do not constitute financial advice
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