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.