China – one year on from the panic

Jade Fu, investment manager at Heartwood Investment Management, comments on how she has held direct exposure to Chinese equities across her portfolios since late 2014. 

We have held direct exposure to Chinese equities across our portfolios since late 2014. We also believe that the performance of the Chinese economy and markets is critical to health of the broader Emerging Markets region.

Needless to say, our exposure at times has been subject to market volatility during some of the more testing periods. It is with this in mind that we recall events one year ago, when the People’s Bank of China made a one-off currency adjustment, the consequences of which rattled world stock markets.

The fracas that erupted after the daily reference rate was lowered by the largest amount in one day since July 2005 was part of broader efforts to bring a more market-determined focus to China’s exchange rate regime.

In recognition of these efforts, International Monetary Fund included the renminbi in its Special Drawing Rights in November 2015. The Chinese renminbi is now one of only five currencies with international currency reserve status.

A further currency adjustment was made in January 2016, contributing to significant market volatility and fears that China’s authorities were losing control of the ‘managed’ slowdown.

Financial markets more comfortable with renminbi depreciation

As global equity markets have settled since early February, it has perhaps been somewhat surprising that financial markets have overlooked the steady depreciation of the renminbi at the same time as the US dollar has strengthened.

The renminbi has fallen 3% versus the US dollar since the end of March, while the US dollar has appreciated 2% on a trade-weighted basis. While the numbers appear relatively small, this trend represents a meaningful shift over the longer term. Since the end of 2013 to the time of writing, the renminbi has depreciated 10% against the US dollar, while the US dollar has appreciated 20% on a trade-weighted basis.

In contrast to the volatility seen at the start of this year, it is noticeable that financial markets seem to be more comfortable with renminbi depreciation. We believe there are three main reasons:

1. The Chinese authorities have made efforts to improve their communications with financial markets and clarify the exchange rate regime, which has gone some way to easing investors’ concerns.

2. Policy measures implemented since late last year are taking effect and we have seen a cyclical improvement in recent months. Second quarter real GDP was reported in line with expectations (7.1% quarter-on-quarter, annualised). Exports have improved, retail sales growth remains solid and manufacturing surveys have stabilised. Moreover, we are continuing to see further progress in the authorities’ efforts to rebalance China’s economy. June’s activity data showed a divergence between shrinking investment in industrial sectors of the economy versus stronger investment in technology and service industries. In particular, fixed asset investment growth continues to slow in industries suffering from overcapacity.

3. Capital outflows have stabilised since March of this year and foreign exchange reserves rose by US$13.5 billion in June, notwithstanding renminbi depreciation and the unfavourable valuation effects of the US dollar. The central bank has also provided indications of further financial market liberalisation, including the opening of the domestic bond market to foreign investors, which could boost flows into China in the longer-term.

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