Everyone seems excited about emerging markets this year, pouring money into EM ETFs as the segment offers investors attractive valuations and some fundamental improvement. But the largest of all emerging markets, China, remains possibly the most misunderstood.
When looking at single-country opportunities among emerging markets, investors of all types—be it retail or institutional—are still “skeptical at best, [filled with] horror at worst” when it comes to China. That’s the assessment of Tyler Mordy, president and CIO of Forstrong Global, and an assessment that a panel of emerging market experts hosted Friday by BlackRock shared.
“We’ve had several emerging market crises over the years, and if you look at the fundamental picture, chances of another crisis are relatively low compared to the West,” Mordy said. “But investors have a lot of scar tissue towards emerging markets, and specifically on China, there’s a lot of misinformation circulating.”
“The West continues to get the story wrong,” he added. “It continues to misread Beijing’s policy signals and misunderstand the Chinese economy.”
So what do investors get wrong about China?
Myth No. 1: The correlation between GDP growth, earnings growth and market performance
For the past few years, market pundits have been saying that China was headed to one place and one place alone: a crash landing. One of the key points they highlight is the slowdown in GDP growth in recent years, now around 6-7% a year, but a far cry from the double-digit days in the early 2000s.
Never has 7% annual GDP growth translated into such muted market gains.
The reality is that China’s economy and the market for Chinese equities—be it mainland or otherwise—has largely decoupled.
Post-global financial crisis, the relationship between GDP and equity market returns “broke down” because policymakers “hit the gas aggressively” with monetary loosening and economic stimulus, said Helen Zhu, head of China Equities at BlackRock. Over time, there has been a switch in the way U.S. investors interpret China growth, she said Friday.
In recent years, even though Chinese growth was still ample, there was growing concern that the quality and sustainability of that growth wasn’t there. Growth coming from massive investment and credit bubbles, and resulting in environmental pollution, social disparity and corruption, was not the type of growth investors were willing to pay up for anymore, Zhu noted.
“So, we’ve seen a decoupling between the growth (GDP and earnings have been growing) and the market (which didn’t go anywhere). Valuations kept coming down,” she said.
But that’s changing. “Now, people aren’t looking for blockbuster growth, but for more sustainable growth combined with the unwinding of some of the problems of previous years,” according to Zhu. It’s a process that’s still in its infancy.
Kate Moore, chief equity strategist at BlackRock, agreed.
“As we look at China, and the breakdown between consumption and investment, we need to break the narrative that there has to be high correlation between GDP and earnings. We’re seeing policy support, supply-side reform and secular growth,” she said.