China shocked investors this morning by devaluing its currency by 2 per cent, making its exports cheaper and its domestic firms relatively more attractive than foreign importers, prompting a raft of selling in many key markets.
Over the past decade, the China has been the best place to invest, with the IA China/Greater China sector average returning 180.5 per cent and a gain in the MSCI China of 241.52.
Performance of sector and indices over 10yrs
Source: FE Analytics
Nevertheless, the Chinese equity market has been in free fall for most of 2015 following its meteoric rise in early stages of 2015 thanks to added liquidity from its central bank and the highly anticipated Shanghai-Hong Kong Stock Connect.
Some have treated today’s news as China is broadly running out of options to control slowing growth and a plummeting equity market. Others see it as a tacit admission that recent economic data has got the central authorities worried.
Trevor Greetham (pictured), head of multi-asset at Royal London says the devaluations adds to the chances of a modest pickup in China’s slowing economy. However, he says China’s strong desire to rebalance its economy away from exports towards the domestic consumer argues against a dramatic devaluation and an economy facing serious headwinds.
“The People's Bank of China has devalued the RMB rate by 1.9 per cent, which doesn’t sound like much but it’s the largest one day move in China’s closely managed currency since a similarly sized upward revaluation in 2005 and a massive devaluation in 1994. I see this as a continuation of the weak Asian currency trend rather than a game changer for Chinese growth,” Greetham said.
“The shock 50 per cent devaluation in 1994 was one of the contributory factors to the deflationary Asia crisis later that decade.”
“Today’s change is tiny in comparison but the central bank will give the market a greater role in setting daily exchange movements and that could mean a more prolonged trend of Asian currency weakness as China’s close trading partners adjust their exchange rates downwards.”
David Madden, market analyst at IG said: “Since Beijing is very protective of the yuan it is a clear sign that it is running out of ideas. China is trying to portray an image of a gentle slowdown, but in reality it is trying frantically behind the scenes to keep its levels high, and traders aren’t buying it.”
Tony Cross, analyst at Trustnet Direct agrees, saying: “The world’s biggest economy is clearly on the rocks, the Chinese government is already depreciating the Yuan in an attempt to prop up exports.”
Chinese equities been an undoubtedly good long term bet, being one of the best place to invest over the past 10 years. However, despite an enormous rally in its domestic stock markets which moved up nearly 200 per cent in a year, and a subsequent rally in the types of shares available to foreign investors, more recently the market has been plummeting.
The MSCI China index is down nearly 25 per cent since 13 April 2015 while the average fund in the IA China/Greater China sector is down nearly 20 per cent over the same period.
Performance of sector and indices since 13 April 2015
Source: FE Analytics
Talib Sheikh, manager of the JPM Multi-Asset Macro fund says it increases his existing conviction to remain negative on emerging markets.
“It also reinforces our view that disinflationary forces across the region are taking hold. We remain significantly underweight emerging market equities and short various emerging market commodity related currencies that will suffer from China’s deterioration,” Sheik said.
“As we see it, risks remain that the China government will need to engage in further measures on the currency.”
However, Simon Cox investment strategist at BNY Mellon believes while the intervention is extreme, he thinks it should not spell a long term knock-back to Chinese equity markets.
“The dramatic stock market intervention from the authorities in the midst of China’s correction could be explained by a degree of panic,” he said.
“They feared the wrath of millions of domestic retail investors, many of whom had bought shares with borrowed money, as well as a narrower circle of corporate insiders who had pledged shares in their own companies as collateral for loans.”
He argues the stock market losses will not heavily damage consumption spending because equities account for a “modest” share of household assets, nor will the collapse greatly hurt investment.
Rob Marshall-Lee, head of emerging and Asian equities at Newton – which is owned by BNY Mellon –says China is still a fertile ground for stock pickers despite today’s news.
“During the weeks of turbulence in the Chinese stock market, valuations ultimately became unsustainable and the sharp decline in the latter half of June and July was a consequence of this. Given the fact underlying profits are still deteriorating, there is arguably further room to fall,” Marshall-Lee said.
He says heavy industry and property sectors are vulnerable as profits and revenues are “under threat” but says he sees growth potential in China’s consumer, healthcare and internet stocks.
Bhaskar Laxminarayan, chief Investment officer of Pictet Wealth Management believes the most pertinent worry is that the Chinese authorities’ intentions are not entirely clear.
“The renminbi is likely to find a new level in the next few days, and to depreciate gradually over the rest of the year. The authorities will not want the currency to depreciate sharply, as this would damage the goal of renminbi internationalisation and stoke capital flight,” he said.
“Capital flight is a concern, but cuts in reserve requirements and interest rates are likely. The liquidity situation appears manageable, and there is not a systemic risk to financial stability.”
“In a context of other measures to support the economy, we expect a small boost to economic activity over the remainder of the year, sufficient to support real GDP growth at just below 7 per cent. The Chinese authorities are muddling through as they attempt to maintain growth at the 7 per cent target, but this is complicating long-term efforts to rebalance the economy.”