Wei Li, Global Chief Investment Strategist together with Elga Bartsch, Head of Macro Research, Yu Song, Chief China Economist and Ben Powell, Chief Investment Strategist for APAC, all part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
Chinese stocks have sold off on concerns that China could tighten monetary and fiscal policy more aggressively – after having led the global restart and policy normalization. This took place as rising U.S. Treasury yields have pressured global risk assets. We see moderately reduced tightening risk after China’s parliament meeting, and keep an above-benchmark strategic allocation to China exposures.
The pandemic has accelerated the rewiring of globalization – with a bipolar U.S.-China world order at its center. We believe it’s key for investors to have exposures to both engines of global growth, and Chinese assets warrant greater than index weight allocations in strategic portfolios. China is still under-represented in global indexes – accounting for less than 10% of both the MSCI ACWI Index (including offshore shares) and Bloomberg Barclays Global Aggregate Bond Index. The relatively low correlation of Chinese assets with global peers offers attractive diversification benefits, in our view. Returns on China A-shares, for example, show a low correlation with developed market (DM) equities, as the chart above shows. The dynamic between Chinese government bonds and their global peers tells a similar story. Chinese government bond have held firm amid a sharp rise in global yields recently. Inflation-adjusted 10-year yields stand above 3%, still way above DM peers.
China has recently lifted most domestic virus restrictions, paving the way for stronger growth – and further policy tightening. Recent better-than-expected Chinese data suggest markets may be underestimating the resilience of the economy. With a focus on improving the quality of economic growth, policymakers have shown a clear willingness to keep liquidity under control and allow occasional spikes in short-term rates – effectively moving in the opposite direction to the rest of the world. This hawkish policy bias has spooked markets, but it may have been largely reflected in pricing, in our view.
China’s leadership set a policy tone that was slightly more dovish than expected at the National People’s Congress (NPC) meeting earlier this month. This moderately reduces the risk of an over-tightening of both monetary and fiscal policy, in our view. The government also set a conservative GDP growth target of “above 6%” for 2021, suggesting it is not trying to maximize short-term growth but still believes a minimum level of growth is needed even as the focus shifts to quality growth. This conservative target also reflects two main uncertainties – the pandemic and U.S.-China tensions, in our view. The Biden administration is engaging in strategic competition with China, particularly on technology, and has criticized Beijing on human rights issues. The tensions were on display in a bilateral diplomatic meeting last week in Alaska.
The more confident Chinese policymakers appear on the macro outlook, the more risks could emerge on the micro level. China’s corporate default rates are lower than global averages, but a higher tolerance for market forces could shutter more “zombie firms” in credit markets; dominant companies in certain industries face risks due to an anti-monopoly campaign.
Even with these risks we see China exposures as core strategic holdings that are distinct from EM exposures. The recent market correction presents a better entry point and more attractive valuations, in our view. We see Chinese government bonds as attractive strategically despite narrowing spreads versus DM peers, and the country’s focus on quality growth should help produce higher-quality companies in the long run. Many Chinese industries are set to benefit from a climate transition as the country pursues its ambitious climate goal. Tactically our preference for Chinese assets is expressed via overweights to Asia ex-Japan equities and Asia fixed income - both heavily skewed toward China exposures. We see a repeat of last year’s strong performance as unlikely this year, yet the accelerated restart still bodes well for Chinese assets.
The Federal Reserve embraced a material improvement in its outlook, while making clear that the bar for reassessing the policy rate path was not met and that it was too soon to talk about tapering bond purchases. This was a clear reaffirmation of its commitment to be well “behind the curve” on inflation and wait to see it to materialize. The rise in Treasury yields in recent months – while quick – is so far much more muted than we would have typically seen in the past. This is in line with our new nominal theme, which we expect to support equities and risk assets on the tactical horizon.
This week’s flash PMI data for key developed economies will be in focus. Investors are eager to gauge the level of activity restart, especially in the services sector that is most sensitive to virus dynamics. We expect the economic restart to re-accelerate significantly this year, as pent-up demand is unleashed and the vaccine rollout eventually enables activity to return to pre-pandemic levels.
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