Chinese leaders already anticipate that the country’s economic expansion in 2015 will be its slowest in 25 years. The gross domestic product (GDP) projection? 7%. Analysts have ridiculed everything about the world’s 2nd largest economy from the nation’s extraordinary debt build-up to the modern-day ghost towns of empty apartment complexes.
Ironically, these same critics barely flinch when the U.S. expansion logs an inexplicably impoverished 0.2% year-over-year. They blame weather patterns for U.S. stagnation, even though California, Texas and Florida experienced typical temperatures throughout respective winter periods. And what happened to lower oil prices serving as a mega-boost to consumer spending? Apparently not. (At least the Federal Reserve believes the economic weakness is temporary.)
Writers tell you that China is falling apart. They tell you that the U.S. is thriving. And then they back up the falsehoods with the disparity in stock market returns. For four long years, investing in SPDR S&P China (GXC) had been an exercise in futility, whereas investing in broad U.S. equities via SDPR S&P 500 (SPY) had been a sensational path for accumulating gains.
It is true that China’s economic growth decelerated from 8%-9% to 7%-7.5% over the four calendar years, but this had little to do with the adverse impact on ETFs like GXC. In reality, China chose not to rely on monetary policy gamesmanship that might depress rates or bank reserves and subsequently spur speculative investment activity. Uneven, unpredictable, sparse stimulus never satisfied market participants.
In contrast, the U.S. Federal Reserve unleashed its largest emergency stimulus package in the 2nd half of 2011. Former Fed Chairman Greenspan has publicly acknowledged that the creation of electronic money to buy trillions in U.S. debt obligations – affectionately known as quantitative easing (QE3) – did little to spur economic growth; rather, it served notice that the central bank of the United States would do whatever it takes to reflate the values of stock, bond and real estate assets. Additionally, global fund flows left places like China and other emerging markets to seek better investment returns in the U.S. Did anyone mind that the U.S. recovery had severely underperformed 3%-3.4% expectations at a substandard 2%-2.4% rate year after year? Not really. The weaker the U.S. economic recovery, the more our central bankers would manipulate rates, keeping them lower for longer and pushing asset prices through the roof.
Something changed at the start of 2015, though. And while it may have began with Europe’s trillion-dollar debt-buying extravaganza, China has been more willing than ever to take aggressive steps. Since November, the People’s Bank of China (PBOC) cut interest rates twice. They’ve also lowered bank reserve requirements. And many anticipate more monetary stimulus.
How has the worldwide investment community responded? Both Guggenheim China Small Cap (HAO) and db X-trackers Harvest CSI 300 China A Shares Fund (ASHR) are up 31% year-to-date. Larger-cap proxies like iShares MSCI China (MCHI) and GXC are up 24% and 22% respectively. In fact, now that the entire world is engaged in extraordinary policy accommodation, at the same time that the U.S. is mulling over slight tightening measures in the near future, should we be surprised by the recent shift in fund flows and fortunes? Even iShares Currency Hedged MSCI EAFE (HEFA) and Vanguard All-World Ex U.S. (VEU) have caught the stimulus bug.
Know this upfront: I am a biased believer in China’s economic might. Part of my mind-set stems from the fact that I lived and worked for a number of years in Hong Kong, Taiwan, Singapore and Thailand; part of my predisposition comes from seeing the work ethic firsthand. Nevertheless, I am not a buy-n-holder. When funds like GXC and iShares MSCI All Country Asia ex Japan (AAXJ) faltered over the prior four calendar years, stop-limit loss orders and trendline breaches removed them from client portfolios. It followed that portfolios had been heavily tilted toward domestic assets and currency-hedged developed market assets throughout 2012, 2013, and 2014.
On the other hand, foreign assets are beginning to look more intriguing with each passing day. The favorable valuation story has always been there… yes. Yet now you are getting confirmation from fund flow, financial engineering and relative strength. For example, according to the iShares web site, iShares MSCI Hong Kong (EWH) has a P/E of 7.7 and a P/B of 1. Yet you are also getting an opportunity to participate in China’s stimulus efforts as well as China’s commitment to structural reforms. Moreover, the recent introduction of the Shanghai-Hong Kong Stock Connect, while having introduced an upswing in speculation in the near-term, is a positive development in forging ties between the peoples on “the Mainland” and in Hong Kong. The relative strength break-out for EWH via the EWH:SPY price ratio is also worthy of attention.
Keep in mind, Chinese Premier Li Keqiuang believes the largest tool in China’s toolbox is structural reform, not lending rates, bank reserves or currency pegs. This is a nation that is willing to struggle through a bit of sub-par exports and sub-par manufacturing to get to place where middle class consumption contributes far more to GDP. The U.S. is 70% dependent on the consumer, which is likely the reason a debt-fueled expansion is so worrisome. China? 40%. They do not need to get to the place where they produce as little as the U.S. is producing, but there’s plenty of room for the middle-class Chinese consumer to purchase cars, clothes and technological gizmos.