What’s happening in China might frighten the life out of most of us, but says Laura Luo, Head of Hong Kong China Equities at Baring Asset Management, the market volatility might be a great opportunity.
Luo blames the volatility over the past month on the consequences of profit-taking by investors and deliberate measures to cool the market. The effects have been amplified by the widespread use of leverage. But, importantly, she believes that the effect on the economy will be limited.
Laura Luo
Luo sees no threat to the Chinese banking sector, or the broader economy. She thinks that the best course of action is to continue to strengthen the economy by providing further monetary support and business reforms.
As for when investors will return to the market, she thinks this will happen as corporate earnings stabilise and economic data improves.
Here’s the complete view from Luo, starting with the volatility:
“We see two primary reasons for the recent volatility in the market.
“The first is profit-taking after a sharp run-up in the China equity markets in recent months. Between the start of 2015 and 12 June, the MSCI China A Share Index returned 62% in US dollar terms, supported by monetary easing, reform measures and flows from retail investors. This left valuations at relatively high levels.
“The second is the decision of the China Securities Regulatory Commission to take some of the excess out of the market by tightening regulations around margin financing and accelerating the process for approving initial public offerings.
“What has been different this time has been the effect of margin financing, which has amplified the volatility. Market estimates are that securities companies had as much as RMB2.27tn (US$366bn) in margin positions outstanding in June, with more in unregulated over-the-counter financing. As share prices moved lower, the pressure to de-leverage by selling shares increased.”
As for the limited effect on the real economy: “As things stand today, it is our assessment that the effect on the economy of the fall in the market will be limited. There could be an impact on consumption from the erosion of most of the gains seen so far this year in the market, while it could also be negative for some areas of the financial sector such as brokerage houses.
“We do not see a wider threat to the banking sector, however, or to the broader economy. In particular, we expect the government to continue to take appropriate steps to boost liquidity, cut interest rates and promote the structural change and reform programme.”
Is this a threat, or opportunity asks Luo: “The authorities have taken a wide range of measures to restore confidence. These include direct and indirect intervention as well as broader steps.
“In our view, the most effective action would be to continue to strengthen the economy by providing further monetary support and business reforms. We expect investors to return to the market as corporate earnings stabilise and economic data improve.
“We cannot rule out further volatility in the short term. The moves we have seen in the market are technical as the amount of leverage has come down. This is not a fundamentally-driven process, and sometimes it goes too far. Accompanying this has been the decision of large numbers of domestic listed companies to suspend trading in their shares temporarily.
“Yet this excess is also an opportunity, in our view. We do not think the investment case for China has changed fundamentally, just the valuation level. On our “quality, growth and upside” analysis, this means higher potential upside over the medium-long term.”
As for the Baring investment strategy: “Our focus on companies likely to benefit from urbanisation and growing demand for services, the rise of China brands and increased efficiency for manufacturers and exporters is a multi-year strategy. Our conviction in the growth potential for quality companies such as L’Occitane, China State Construction and AIA Group Limited is high, and we are likely to take advantage of any further volatility to add to companies where we see a strong investment case.
