28 January 2021 |

CIO Weekly – Featuring Charles-Henry Monchau of FlowBank

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This week: FlowBank: China’s equity markets are undervalued, under-owned and under-appreciated; LGT Private Banking: Equity markets vulnerable to setbacks this year; T. Rowe Price: Secular growth stocks, at the right price, should continue to compound good returns; BlackRock: Slowing of Fed easy policy hinges on signs of durable growth and employment momentum; PIMCO: Fed can successfully engineer a smooth shift in monetary policy; Capital Group: Debt levels sustainable over a three to five-year time horizon

FlowBank: China’s equity markets are undervalued, under-owned and under-appreciated

“Global markets are currently full of crowded trades, but in that respect China does not look to be one of them,” Charles-Henry Monchau, chief investment officer at Swiss online bank FlowBank, told Asian Private Banker. Monchau is a 25-year veteran in multi-asset investing, including as head of asset allocation EMEA at Deutsche Bank, and CIO Europe at EFG Bank.

Trades such as technology stocks and relative value may get increasingly crowded from the glut of liquidity, but RMB-denominated and locally-traded equities (known as China A-shares) still stand out for global investors.

Betting on China would be to bet on a global rebound from the COVID-19 pandemic as the country is expected to become the world’s largest economy in purchasing power parity terms by 2024, he added.

China is a play on foreign direct investments as it remained the number one destination for FDI in 2020, despite protectionism and tariffs, said Monchau.

Chinese equity markets continue to offer a higher risk-adjusted return potential as earnings growth is strong on the back of robust economic growth, even as valuations continue to trade at a steep discount relative to US peers, Monchau said.  

 

“It is one of the few underinvested markets and it is vast, liquid and now more accessible,” Monchau told Asian Private Banker. “If you look at some global equity managers survey, 75% of them do not have any A-shares exposure,” he noted. “The same survey shows that the aggregated A-shares exposure is less than 1%,” he said. “This looks small for an economy which is expected to become the largest in the world,” Monchau added.

Net flows by Morningstar Fund Categories. Source: Morningstar Direct • Click on image for PDF file

An instrument of choice for global investors has been US-listed American Depository Receipts of Chinese companies. But recent delisting risk means that domestic A-shares and Hong-Kong listed stocks are “now safer options,” noted Monchau. “Let’s keep in mind to that ADRs give exposure to a Cayman company instead of the Chinese domestic one directly,” he pointed out.

Chinese equities constitute less than 10% of MSCI Emerging Markets index but the weight is expected to increase meaningfully, said Monchau. “We do see Chinese equities becoming a stand-alone allocation within global portfolios, and this is likely to trigger massive inflows in this market, he told Asian Private Banker.

Funds available for sale in Hong Kong or Singapore recorded US$53.0 billion of net inflows for the full year of 2020, versus US$62.6 billion the previous year, Morningstar Direct data showed.

“China A-share funds experienced record inflows as investors take advantage of the stabilisation in Chinese economic growth and the abundance of alpha opportunities on offer,” said Wing Chan, Morningstar’s director of manager research practice, EMEA & Asia.

From a political perspective, authorities in Beijing seem to have a strong motivation to ensure a robust domestic equity market, opined Monchau. “They want a strong capital markets ecosystem, providing customers with a strong savings scheme and giving local companies easier access to capital,” he said.

From a thematic perspective, the “consumption-oriented story” of China looks appealing, according to FlowBank. “The ones which will benefit are going to be the entrepreneurial businesses providing online commerce, electric vehicles/batteries, healthcare services, telecom infrastructure or sustainable energy,” said Monchau. 

To be sure, Monchau acknowledged risks to his thesis — including the high level of debt in China, a monetary policy which could become more hawkish at some point (as the PBoC may want to limit some of the excesses) but also China-US tensions which are likely to stay. While the Biden administration is likely to be more diplomatic than the outgoing one, the Democratic president “is not in a rush” to calm down tensions and the trade war, said Monchau. He pointed out that this was the first time since 1979 that a Taiwan representative attended the US presidential inauguration speech. “That tells a lot,” he said.

According to many metrics, China’s equity markets look “undervalued, under-owned and under-appreciated, while providing superior risk-adjusted returns,” said Monchau.

“At this stage, international investors are still not sizing the opportunity,” Monchau said. “From a contrarian perspective, this looks appealing,” he added.

LGT Private Banking: Equity markets vulnerable to setbacks this year

The extreme positioning for a strong recovery in corporate earnings this year makes equity markets vulnerable to setbacks, said Thomas Wille, head research & Strategy, LGT Private Bank. “The road to further gains is therefore likely to be rockier,” he said.

“In the months from November to January, investors can generally achieve above-average returns on equity markets, as history shows,” said Wille. This has been the case too for the past three months, he noted.

“The coming weeks are likely to be somewhat tougher and we expect higher volatility in capital markets,” said Wille. “However, this does not affect our constructive stance for the year as a whole; rather, we expect a period of digestion of price gains after the recent surge,” he said. In addition, the extreme positioning on the markets could provide headwinds as the last two months have seen record inflows into equities, said Wille.

“While this is not unusual for the period from December to January, but nevertheless incremental buyers are likely to fall away in the near term,” he said. “Both factors – seasonality and positioning – are unlikely to herald the end of the bull market in equities, but the road will be rockier and more arduous.”

T. Rowe Price: Secular growth stocks, at the right price, should continue to compound good returns

Investors trying to make money in this environment need to be more selective and active, which may at times mean taking a more contrarian approach, said Scott Berg, portfolio manager, global growth equity strategy at T. Rowe Price.

Looking out to the rest of 2021, the American asset manager remains optimistic when analysing the return potential of global equity markets. “However, volatility is likely to increase in part, as higher dispersion within factors, styles, and sectors emerges,’ notes Berg.

“We expect the COVID-on/COVID-off trade to continue to flip-flop back and forth, as it did through the later stages of 2020,” Berg said. “We believe secular growth stocks, at the right price, should continue to compound good returns, but the setup into midyear might imply a continuation of the rotation trade into value, small-caps, and non-US stocks that began toward the end of last year,” he added.

BlackRock: Slowing of Fed easy policy hinges on signs of durable growth and employment momentum

The Fed’s FOMC statement and press conference, as well as some of the weaker economic data, may tamp down some of the market commentator chatter over the Fed needing to taper its accommodative policy stance for a time, said Rick Rieder, BlackRock’s chief investment officer of global fixed income and head of the BlackRock Global Allocation Investment Team. “But it’s important to remember that the monetary policy maker’s role has historically been more reactive than anticipatory of economic change,” he added.

“The pace of the recovery in economic activity and employment has moderated in recent months, with weakness concentrated in the sectors most adversely affected by the pandemic,” the FOMC statement reads. Specifically, the December non-farm payrolls report registered a loss of 140,000 jobs on the back of COVID-inspired weakness in the leisure and hospitality and education sectors, Rieder notes. Further, retail sales have disappointed of late too, with concerns over COVID spread, as well as new variants of the virus, sapping some economic momentum, he said.

“Still, Fed chairman Powell’s tone in the press conference could be described as hopeful, while recognising that the economy isn’t out of the woods yet,” said Rieder. “Fed’s often cautious stance of being early to ease and slow to tighten is likely in place now,” he added.

“As a result, we will need to see durable growth and employment momentum before talk about reducing the pace of easy policy becomes realistic,” said Rieder. In the view of the US$2.7 trillion asset manager, the earliest there would be serious consideration of changes to guidance is likely at the June meeting.

PIMCO: Fed can successfully engineer a smooth shift in monetary policy

PIMCO thinks the Fed may be planning for a range of scenarios, including one in which it will eventually be appropriate to start to gradually reduce accommodation. “At that time, as the Fed starts to discuss its eventual exit, it will want to avoid a premature tightening in financial conditions,” said the manager of US$2.02 trillion in assets. “And while some commentators have raised the spectre of another “taper tantrum,” we think the Fed can successfully engineer a smooth shift in monetary policy, when it does become appropriate,” it added.

Eventually [Fed chairman Jerome] Powell will need to start communicating the Fed’s plans to begin winding down its asset purchases, especially if the US economy makes substantial progress this year toward the Fed’s inflation and employment goals, noted PIMCO. “When this time comes, the Fed will want to communicate in ways that generate a smooth exit with a gradual rise in interest rates,’ said PIMCO. It estimates three notable approaches for the Fed:

  • The New Neutral: The Fed can emphasise that the real neutral interest rate remains low, and may well be even lower after the pandemic-related recession, despite policymakers’ efforts to minimise longer-term economic scarring.
  • Two distinct and separate policies: Fed officials should once again try to disentangle changes in their asset purchase programmes with market expectations for the timing of changes in the policy rate. If the Fed can anchor rate expectations at the same time it begins to reduce bond purchases, we think it should be able to limit the bond market sell-off.
  • Communicate well in advance and in detail: The Fed should communicate early any plans to wind down the asset purchase programmes, perhaps by releasing a pre-set tapering schedule, as it did ahead of the 2017 balance sheet reduction programme. Indeed, by communicating that programme well in advance, the Fed managed to minimise bond market disruptions associated with more Treasury supply.

Capital Group: Debt levels sustainable over a three to five-year time horizon

The Capital Group doesn’t expect interest rates to rise by much if the private sector behaviour remains “very cautious.” “Therefore, governments will find it easy to fund these deficits and debt levels for a considerable time,” opined Robert Lind, economist at Capital Group.

“The challenge would come if we did start to see upward pressure on interest rates, either because of a pickup in inflation, or because the private sector saw more risk appetite,” he noted. “In those circumstances, governments would have to consider whether to go down the road of financial repression,” said Lind.

“However, we believe that in the next few years, any rise in interest rates or inflation is likely to be relatively modest by the historical standards that we saw in the 1970s and 1980s,” Lind said. “In that sense, these deficits and debt levels should be sustainable, at least over a three to five-year time horizon.”