Morgan Stanley
  • Wealth Management
  • Mar 22, 2021

China’s Sell-Off May Be an Investing Opportunity

Worries over China’s growth path and monetary policy have recently hampered equity performance, but investor concerns may be overblown.

Since February’s sell-off, partly attributed to fears over rising interest rates, the broader U.S. market has rebounded and even climbed to new highs, but the same can’t be said of the technology-and-growth-heavy Nasdaq or emerging markets. China’s stock markets have been hit particularly hard, with one key equities index down 14% this past month, outpacing the Nasdaq’s 6% decline. 

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Many investors may be worried about further downside in China, given its maturing economy and the potential for its central bank to respond with higher rates, amid signs of higher global inflation. 

We think such concerns may be overblown. In fact, the recent equity sell-off may be an opportunity to add selectively to China allocations in portfolios.

Remember that China was the first country to shut down due to COVID-19, and the first to recover. Indeed, it was the only major economy to post any economic growth in 2020, at 2.3%. Still, China pessimists worry that its expansion is unsustainable and it might not meet its 6% GDP growth target for 2021 due to the bumpy recovery in global trade, moderating domestic credit and rising debt loads.

These concerns overlook two key points. First, rather than weighing on Chinese companies’ cost of capital, rising U.S. real yields and inflation expectations actually help to stem the dollar’s weakness against the renminbi, a potential positive for Chinese exporters

Second, and perhaps more important, pent-up demand and excess household savings in China could drive 8%-10% growth in consumption over the next two years, according to Alpine Macro, an independent research firm.

Another key growth dynamic: Massive stimulus and deficit spending in the U.S., Europe and Japan, while implemented to counteract the pandemic, may lead to a dreaded “fiscal drag” on these economies once they run down. That’s less of a concern in China, where the government’s one-time stimulus to counter the pandemic amounted to only 1.5% of GDP—compared to as much as 30% spread over multiple policy moves for major developed nations.

Concerns over more restrictive monetary policy in China may also be misplaced. Unlike in the U.S., China’s real yields have already moved in solidly positive territory, which may obviate the need to raise rates anytime soon. What’s more, reflationary bond repricing has already occurred, with 10-year China bond yields sitting at a relatively stable 3.3%, up from a trough of 2.5% last March. Meanwhile, nationwide stockpiling of oil last year should partially insulate China from higher energy prices—and inflationary pressures—in 2021.

We recommend that investors consider using emerging-market weakness as an opportunity to add to China A-Shares, which are more leveraged to global pro-cyclical and value themes than expensive tech and social media names.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from March 22, “A Double Whammy for Chinese Equities.” Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this report.

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