A rift has opened up between Chinese equities and the rest of emerging market stocks in recent weeks as recoveries from the pandemic have diverged. This separation should be short-lived, say fund managers.
Chinese stocks appear to be regaining lost ground as extreme pessimism about its economy eases and authorities take further steps to revive faltering growth. At the same time, growing enthusiasm for other emerging market stocks could wane in the face of a global slowdown, causing their correlation with China to be reconfirmed.
Bloomberg
“I’ve seen this decoupling story many times over the last 2+ decades, it never works out,” said Zhikai Chen, head of Asian and global emerging markets equities at BNP Paribas Asset Management, which has the equivalent of $504 billion globally administered in late June. “From the point of view of trade flows and how big the Chinese economy is for commodity demand, that seems like a heroic assumption.”
The MSCI China Index is down about 6% over the past month, while a similar MSCI indicator, which tracks the rest of the emerging markets, is up 7% over the same period. The same disparity has also emerged in bond markets, with Chinese bonds returning less than 1% compared to a 4% return for emerging markets as a whole.
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Valuations for Chinese stocks have gotten so low that there is plenty of room for a recovery once sentiment stabilizes. Authorities signaled their intention to boost growth last week, with the central bank unexpectedly cutting a key interest rate. The government may take more pro-growth measures ahead of the National Party Congress, which is expected to be held later this year, as President Xi Jinping seeks a third term.
Bloomberg
Meanwhile, doubts are mounting in the rest of the emerging markets.
The dollar has started to strengthen from low levels earlier this month, slowing overall inflows of foreign funds to developing countries. Financial conditions are also tightening around the world as central banks raise interest rates to curb inflation, weighing on growth prospects for many emerging markets. Close ties to the slowing US economy should also weigh on performance.
Emerging markets outside of China have held up “perhaps largely due to over-optimism that the US economy will not slow as much as previously expected and that the Fed will not have to tighten monetary policy as much,” said David Chao, a global markets strategist in Hong Kong at Invesco, which had $1.45 trillion under management as of July. “I’m not sure I’ll buy this.”
In Asia, South Korea and Taiwan appear particularly vulnerable, as declines in spending by their largest customers, such as Apple Inc., underscore a slowdown in demand for chips from index-heavyweight makers.
However, some sectors in emerging markets outside of China could continue to outperform, with Indonesia and Brazil being supported by energy stocks and India by financials, which are thriving amid a revival in domestic demand.
Reasons for re-pairing
The divergence between China and other emerging markets will also gradually close as the slowdown in the world’s second largest economy spreads to its closest trading partners such as Korea and Malaysia.
“Over the long term, whether emerging markets can ‘decouple’ from a slowing China to outperform depends on their starting valuations and whether they have growth drivers outside of exporting commodities to build Chinese homes and infrastructure,” Ian said Samson, a fund manager at Fidelity International in Hong Kong.
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