Hidden in China’s domestic stock market is a catalyst that many investors may be missing.
Today we have a guest post by Jerry Zhang, Ph.D., CFA, and Derrick Irwin, CFA, of the Wells Fargo Emerging Markets Equity Fund.
China’s shift toward consumer-facing industries might be capturing the market’s imagination. But for investors, there’s more to the story. To capture the right opportunities, you need to know which companies in China are reimagining themselves and their product offerings to meet the shifting behaviors and preferences of the country’s consumers.
China’s consumer sector: Not a straightforward trend
Much has been written about the need for China to transition its economy away from investment-driven growth and toward a more service- and consumption-oriented economic model. Often, this is discussed in terms of a transition that is barely beginning. In fact, China’s economy is well down the road toward this goal, and services and consumption now account for more than half of China’s gross domestic product and are growing more quickly than traditional, investment-led industries.
Between now and June 16, there likely will be banners scrolling and TV personalities talking over each other, debating whether the economy and the market can take a rate hike in June. A lot of the debate and hyperbole likely will miss an important point: it’s not so much the Fed as the yuan that investors should be watching. The big question on my mind is will the People’s Bank of China (PBOC) depreciate China’s currency relative to the U.S. dollar in anticipation of a Federal Reserve (Fed) hike?
Why care about the yuan? It helped cause the last correction.
On December 11, 2015, the PBOC announced the creation of the China Foreign Exchange Trade System exchange rate to provide an alternative to targeting the yuan versus the dollar. Why is this date significant? It was, quite conveniently, a few days before the Fed hiked rates on December 16.
Dr. Brian Jacobsen helps you connect your clients to the top stories in the capital markets.
Wayne Badorf: This week, our focus in on central banks and on China. I’m Wayne Badorf and this is The Essential Practice. I’m joined today by Dr. Brian Jacobsen. Brian, welcome.
Brian Jacobsen: Thanks for having me back.
Wayne: There’s news this month coming from the European Central Bank (ECB), the Bank of Japan (BOJ), and the Fed. Can we key in on facts advisors should pay attention to?
Brian: Yes. I think if you reflect back on the first quarter of 2016 and what drove some of the volatility and some of the market recovery—they were driven by China and some of the central banks. There was disappointment around the BOJ’s program of negative interest rates; markets didn’t seem to like that too much. And then it was really when the ECB said we’re going to expand our asset-purchase program and, come June, basically bribing banks to begin lending again through its long-term targeted refinancing program that helped turn things around in the first quarter and has continued some of the momentum we’ve seen here in early April.
The markets seemed to share the Federal Open Market Committee’s concerns about global growth, shown in its minutes yesterday. European and American indexes declined, while safe-haven assets like gold and the yen strengthened, with the latter at one point reaching a more-than-two-year high against the dollar. The S&P 500 Index slipped into the red for the year.
The Dow sank 174 points, with 27 of its 30 components retreating; the S&P 500 Index lost 24, led down by the financials sector; and the Nasdaq dropped 72. Decliners led advancers by 10 to 3 on the NYSE and 11 to 4 on the Nasdaq. The prices of Treasuries strengthened. Gold futures rose $13.70 to close at $1,237.50 an ounce, while the price of crude oil dropped 49 cents in heavy trading to settle at $37.26 a barrel.
In other business news:
When it comes to investing in emerging markets companies, selectivity is key.
Indeed, international markets posed several challenges for investors in early 2016. This includes official confirmation that China’s economy registered its slowest growth in years and the ongoing political scandal and economic depression in Brazil. At the same time, you’ll see pockets of opportunity if you look past the headlines. China is continuing its long transition from investment-led growth to a more balanced economy. As we mentioned in our last blog post, in absolute terms, China’s household consumption grew by approximately 188% between 2006 and 2014, driven primarily by urban consumption. India, meanwhile, has one of the fastest-growing economies in the world.
Here are four international developments that we think investors should focus on:
1. China’s continuing transition from investment-led growth
The headlines are focusing on China’s headline number for growth in gross domestic product (GDP), which dipped below 7% in 2015 for the first time since 1990. However, we are more interested in the growth of the service side of the economy. China’s tertiary industry, the services sector, surpassed construction and manufacturing for the first time in 2012 and now represents more than 50% of the economy.
Stocks pulled back from their five-day rally after disappointing trade data out of China and declining oil prices.
The Dow fell 109 points, with 21 of its 30 components retreating; the S&P 500 Index lost 22; and the Nasdaq dropped 59. Decliners led advancers by three to one on the NYSE and seven to two on the Nasdaq. The prices of Treasuries strengthened. Gold futures fell $1.10 to close at $1,262.90 an ounce, and the price of crude oil sank $1.40 to settle at $36.50 a barrel on growing skepticism about production freezes. Trading volume was heavy.
In other business news:
The improving U.S. economic data that rallied the U.S. stock market yesterday carried over to Asian and European shares. Japan’s Nikkei Index and China’s Shanghai Index both surged more than 4%. European indexes posted more moderate returns but were broadly higher. U.S. major indexes were more cautious after the rally yesterday, spending most of the day near the flat line but closing in the green.
The Dow rose 34 points, with 17 of its 30 components advancing; the S&P 500 Index gained 8, led by the energy sector; and the Nasdaq rose 13. Advancers led decliners by two to one on the NYSE and the Nasdaq. The prices of Treasuries were mixed, with the 30-year strengthening and the 10-year weakening. Gold futures jumped $11.00 to close at $1,241.80 an ounce, and the price of crude oil rose 26 cents to settle at $34.66 a barrel.
In other business news:
The health of China’s economy is one of the key questions facing investors. Although stock markets face challenges across the globe—which range from the low price of oil pressuring energy producers to the rise of nonperforming loans in major economies such as Italy—the prospect of a deflationary collapse in China seemed to weigh heaviest on stock prices. China’s economic growth rate has indeed slowed, edging beneath 7% in 2015 for the first time since the first quarter of 2009. Yet, when we spoke with three professional money managers that have long experience investing in China, they all believed that the concerns were overdone.
“The idea that there is no further growth in China is clearly ridiculous,” says Anthony Cragg, co-portfolio manager of the Wells Fargo Emerging Markets Equity Income Fund and the Wells Fargo Asia Pacific Fund. Citing the 2015 IMF World Economic Outlook, Mr. Cragg notes: “On an absolute basis, the amount that the Chinese economy grows each year is equivalent to the entire economy of the Netherlands.”