China’s Elite Role in Emerging Markets Has Traders Creeping Back

“There’s no way that any global investor can ignore China unless there’s a complete embargo by the U.S,” said Mark Mobius.

China’s Elite Role in Emerging Markets Has Traders Creeping Back
A public screen displays the Shenzhen Stock Exchange and the Hang Seng Index figures in Shanghai, China. (Photographer: Qilai Shen/Bloomberg)

A recovery in Chinese stocks following a meltdown at the start of last week underscored how investors in emerging markets have few alternatives that are as big and liquid.

After ditching the Asian nation’s assets amid the turmoil, there are already signs that folks are creeping back. Traders piled a net $975 million into Chinese exchange-traded funds last week, more than all other developing nations tracked by Bloomberg combined. The benchmark CSI 300 Index rose as much as 2.7%, its best day since May 25.

China’s Elite Role in Emerging Markets Has Traders Creeping Back

“There’s no way that any global investor can ignore China unless there’s a complete embargo by the U.S. government,” said Mark Mobius, a veteran investor in emerging markets who spent three decades at Franklin Templeton Investments. “But that’s very unlikely.”

Despite all the risks associated with investing in the world’s second-largest economy, the sheer breadth of the market and its outsized share in key indexes means money managers often have no choice but to look past bouts of turbulence and maintain exposure.

China’s Elite Role in Emerging Markets Has Traders Creeping Back

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While the latest manufacturing data out of China point to a slowdown in activity, the nascent rebound in the nation’s battered equities may have room to run if funds begin to rebuild their positions and liquidity injections restore calm in financial markets.

Unsubstantiated rumors that Washington was going to restrict funds from investing in China and Hong Kong exacerbated the rout last week, which kicked off as Beijing widened a regulatory crackdown on its burgeoning tech industry. On Sunday, China’s securities regulator called for talks with its American counterpart after the U.S. Securities and Exchange Commission halted the initial public offerings of Chinese companies.

Regulatory Crackdown

At the height of the panic, Hong Kong’s Hang Seng index was down almost 10% from last Friday’s close. Technology giant Tencent Holdings Ltd. shed about a fifth of its value and Meituan tumbled as much as 30% in the week.

But as the dust settles, focus is already turning to the money that eventually poured back into the country’s assets after an epic stock-market bust in 2015 and amid government efforts to stem steep declines in 2018. Exchange-traded fund investors were seen buying the dip in China last week, as cash flowing into U.S.-listed emerging market ETFs were led by inflows to funds tracking Chinese assets.

China makes up about one-third of MSCI Inc.’s emerging-market index, which means that it’s almost guaranteed to attract funds from money managers who track the benchmark. The promise of juicy gains will only help -- equity investors in China pocketed twice the average return across the developing world over the past decade.

“If one wants out, one could divest from China and invest the proceeds pro-rata across other countries,” said Gustavo Medeiros, London-based deputy head of research at Ashmore Group Plc. “But this is extreme.”

The economy’s closed nature can also insulate assets from volatility, with some investors even snapping up government bonds as an alternative to U.S. Treasuries. Inflows drove the yield on 10-year Chinese benchmark debt down almost 30 basis points this year, the most among major markets.

Low Correlation

So far in 2021, total assets invested in China via ETFs reached $252 billion, compared with about $10 billion in Brazil and $2.5 billion in South Africa.

“It’s very uncorrelated with other markets so not sure you can say who else would benefit,” said Charles Diebel, a money manager at Mediolanum SpA. “Because of the size of China, no alternative exists with the same risk profile.”

Last week’s rout also offered an opportunity to buy up assets on the cheap. The forward price-earnings ratio of the Shanghai Composite Index fell to a one-year low, bringing China’s valuation discount versus U.S. stocks to 45%, compared with a 20-year average of 11.4%.

“We see this selloff as an opening to add to some of our existing positions,” said Ali Akay, the London-based chief investment officer of hedge fund Carrhae Capital, which manages about $760 million in assets, pointing to “very attractive valuations.”

That’s not to say investors aren’t scouring other emerging markets for opportunities after the shake-up.

For Sergey Dergachev at Union Investment Privatfonds GmbH in Frankfurt, markets that benefit the most from lower U.S. Treasury yields such as Russia and Turkey stand out. The benchmark MSCI equity index for emerging markets rose 1% Monday led by technology and health care stocks.

Still, there’s a sense that are few places within the asset class to escape if the market turns south again. “If the selloff in China credit continues, there would not be many places to hide in EM,” said Paul Greer, a money manager at Fidelity International.

Rate Decisions

  • The Bank of Thailand will likely keep its one-day repurchase rate at a record low 0.5% on Wednesday to support its economy, which could be the worst performer in Southeast Asia this year. The latest Covid-19 outbreak has dashed hopes of a revival in the tourism industry while political unrest has increased with the return of pro-democracy protests since late June

    • “We see mounting risks of a 25 basis-point rate reduction” even though the central scenario calls for no change, Eddie Cheung, senior emerging markets strategist at Credit Agricole CIB in Hong Kong, wrote in a note
    • Thailand’s economy is a regional underperformer in terms of growth and inflation is likely to be among the lowest in the region, he said
    • The baht is Asia’s worst-performing currency this year
  • The Reserve Bank of India is expected to hold its benchmark interest rate on Friday, prioritizing a growth revival over containing inflation

    • Retail inflation has already exceeded the RBI’s 2%-6% target band for two straight months
    • India’s price pressures are likely to remain elevated in the coming months and “we look to bring forward the timing of the first 25 basis-point rate hike from third quarter 2022 to early 2022,” ING Groep NV wrote in a note
    • The rupee has dropped nearly 2% this year
  • Czech policy makers are expected on Thursday to raise rates for a second consecutive meeting
    • The koruna was among the top emerging-market gainers last week after central bank Deputy Governor Tomas Nidetzky said the monetary authority should keep lifting interest rates at a swift pace
  • Brazil’s central bank is expected to increase its key Selic rate by a full point to 5.25% on Wednesday following an uptick in 2022 inflation expectations and the real’s underperformance last month
    • Traders will also watch June industrial production figures on Tuesday
  • Colombia’s monetary authority will release July meeting minutes on Tuesday, providing investors with a snapshot of the policy path
    • A reading of July consumer price inflation on Thursday may flag an increase compared to June
  • Elsewhere, Egypt may keep its benchmark rate on hold on Thursday, while Romania probably maintains its key rate the following day

What Else to Watch

  • South Korea’s exports of chips, computers and other technology products helped boost overseas sales to a record in July, even as the pace of growth in overall shipments slowed
  • Manufacturing managers in Southeast Asia saw a slump in activity as the region grapples with one of the world’s worst Covid-19 outbreaks, while North Asia continued to see a pick up as the global economy recovers
  • Indonesia reported on Monday consumer-price inflation quickened to 1.5% in July from a year earlier compared with 1.3% in June. Similar data will be released by South Korea on Tuesday, and the Philippines, Thailand and Taiwan on Thursday
  • Indonesia is expected to report on Thursday that its economy grew 6.7% in the second quarter from a year earlier

    • Southeast Asia’s largest economy probably registered positive growth for the first time in five quarters due to low base effects and improving activity although the recent Covid outbreak is a setback to the recovery, according to analysts
  • China is scheduled to release July trade figures on Saturday. Its export growth unexpectedly picked up in June
  • In Turkey, data due Tuesday will probably show that inflation accelerated in July because of higher oil prices and a weaker currency, reducing the odds of a rate cut in August
    • Prices probably rose an annual 18.6% in July, from 17.5% the previous month
    • The lira led emerging-market gains in July
  • While Russia’s inflation rate likely ticked up slightly in July, monthly inflation should slow on a seasonally adjusted basis, an encouraging sign for the Bank of Russia, according to Bloomberg Economics
    • The central bank will probably hike rates again in September after raising borrowing costs by 225 bps since March
    • The ruble has outpaced all of its developing peers this year
  • A reading of Chile’s June economic activity index on Monday will probably show another year-on-year rise as expansionary fiscal and monetary policies support growth, according to Bloomberg Economics. Inflation data on Friday may show an increase in July
  • Traders will be keen to see if Peruvian assets extend their losses in the shadow of President Pedro Castillo’s inauguration and his call for a new constitution
    • Castillo named former World Bank economist Pedro Francke as his finance minister and swore him in late Friday evening following a delay that unnerved investors and sent the sol slumping to an all-time low
    • Francke called for a “clear separation” between party politics and the government, addressing a key investor concern on his first day in the post on Saturday

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