May 2017

Bulls in a China Shop?

BlackRock recently held a roundtable discussion on China bringing together the press with industry-leading investors. While many investors have doubted the sustainability of Chinese growth, our panel believes that China’s policies are normalizing and feel significant opportunities may exist for those willing to avoid consensus trades. Three themes emerged from the discussion:

Access China via China

US investors have often sought to access China indirectly, through developed market multinationals (e.g., outsourced manufacturing) or commodities. But proxy trades miss the real domestic opportunity. The MSCI China Index has seen the weight of IT grow from 7% five years ago to 35% today and consumer discretionary move from 6% to 10%1. Over the same period, the MSCI World with China Exposure Index underperformed the MSCI China Index by 12%1.

Seek to capitalize on attractive valuations

The relationship between Chinese equities and economic growth has been disconnected, with annualized GDP growth of 10% the last 16 years vs MSCI China Index returns of 6%1. Today, our panel sees a new pattern: more even-keeled policies seeking sustainable growth and unwinding excess leverage. However, markets have been slow to reflect improvements in valuation gains. Even as China’s share of global exports increased 17% the last five years (to more than 12% of the global pie), neither the price-to-book nor forward earnings of the MSCI China Index have traded at a premium to the MSCI World or All-Country indices2. If this recent growth is indeed more sustainable, a valuation lag could be creating upside opportunity.

Chinese Equity Indexes
Comparison of domestic China equity benchmarks

Chinese Equity Indices

Source: Thomson Reuters as of 5/16/17; Note: Indices represented are the MSCI China A Index, MSCI China Index, MSCI China Real Estate Index, and MSCI China A Financials Index. Index returns are illustrative only. Index performance returns do not reflect management fees, transaction costs or expenses. Indexes are unmanaged; one cannot invest directly in an index. Past performance does not guarantee future results.

Consider the old, not just the new

Investor attention has been focused on the “new” Chinese economy: sectors like tech and consumer, both of which have shown strong growth and price momentum. But for investors willing to look beyond the latest trend, the “old” economy, in particular financials and energy, has been where valuation upside opportunities were most successful this year. Notably in financials, the panel felt that pessimism around the yuan has been overblown, and onshore yields have moved higher, driving returns for the sector. So, when investing in China directly, different vehicles and benchmarks provide unique ways to play the “new/old” divide.  For example, MSCI China A Index (local A-share market) has a lower weight in IT versus the MSCI China Index but a relatively higher weight in healthcare with similar consumer discretionary exposure.

Comparing sector breakdowns
MSCI China Index vs. MSCI China A Index

Source: BlackRock and MSCI, as of 5/16/2017.

Share of exports going to China
Exports to China as % of total exports

Source: BlackRock and MSCI, as of 5/16/2017. Note: G20 members with over 9% of total exports to China shown.

 



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