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Why Fidelity is bullish on China

Glenn Freeman  |  16 Jun 2020Text size  Decrease  Increase  |  
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Credit products currently hold more appeal for Fidelity’s multi-asset team than equities, and they particularly like Chinese government bonds and high-yield credit.

George Efstathopoulos, a Fidelity multi-asset portfolio manager, suggests Chinese government bonds have been sold off because of a policy shift. This has seen regulators trying to stop smaller businesses taking advantage of record low interest rates to buy structured credit products.

These are essentially loans and mortgages that have been packaged into interest-bearing securities backed by those assets and issued to investors.

“And if you compare that to what’s happening in the European Union, that’s been somewhat encouraged – banks have been encouraged to buy structured credit,” Efstathopoulos says.

“CGB real yields have been very attractive versus other markets, especially as the CPI inflation headline rate has come down.”

The 10-year Chinese government bond yield is currently above 2.7 per cent, versus around 0.7 per cent for US 10-year treasury notes and 0.2 per cent for UK 10-year gilts.

“We’ve been buying them…we like them, particularly in a world of zero bond yields,” says Efstathopoulos.

Rising foreign ownership of Chinese bonds

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Source: Fidelity International, People's Bank of China 23 April 2020

Iron fist benefits

In equities, Fidelity still sees opportunity within the technology sector, and particularly in Asia, says Paras Anand, CIO for Asia-Pacific.

"We've seen a quantum leap in digitisation and certain use cases are going to see an acceleration in terms of demand, but we’re conscious of valuations,” Anand says.

While the higher rates of control exercised by the Chinese government are often viewed through western eyes as a liability, Anand sees it as a positive in some cases.

“In the US, the large tech platforms are the incumbent monopolies, and they’re the ones that tend to attract a high degree of government scrutiny,” he says.

Facebook and Uber are prominent examples in the US, having faced regulatory backlash that Anand suggests can evolve and potentially impact their business models.

“Whereas in China, the large tech platforms have generally had party membership on their boards, or party boards as part of their supervisory structure, so they’ve been developed with that view all along,” Anand says.

Because Chinese companies such as internet gaming giant Tencent have been developed within such constraints, he says they’re much less likely to be hit by retrospective regulation.

In company sectors, Fidelity also likes:

  • Healthcare, a traditionally defensive sector
  • Telecommunications, particularly as 5G technology progresses
  • Financials, given discounts in the low interest rate environment.

With unemployment in the US at more than 9 per cent, Fed Chair Jerome Powell last week conceded millions had lost jobs and tipped a recovery and a lift in interest rates could “take some time, and I think most forecasters believe that.”

Efstathopoulos says he and his team are increasingly nervous at the disconnect between markets and economies. “And we think the upside-downside divergence warrants caution.”
He believes investors are too quick to embrace assumption as fact in the current environment, as they struggle amid widespread uncertainty.

Fear of missing out

Efstathopoulos suggests investors are placing too much emphasis on the surprising upside in the latest US jobs data, which was better than most commentators had expected.
“Potentially we’re placing undue weight on the surprise element. But the absolute unemployment rate is still at levels not seen since the Great Depression.

“The longer the return to normality takes, the more bankruptcies we see, this will eventually cause temporary employment to become more permanent,” says Efstathopoulos.

He says that many investors were too quick to sell when the S&P/ASX200 lost around 25 per cent of its value between 20 February and 20 March. And the opposite is now occurring.

“It was sell now, ask questions later and now it’s the exact opposite.”

Generalisations are useless

Many investors rely on modelling and assumptions about markets to decide where to focus their portfolios.

But Efstathopoulos and Anand believe predictions are increasingly unreliable: “The impact for individual companies and for individual economies is going to be widely varied.”
As an example, Anand points to the lack of a “uniform demand shock” across different sectors since the coronavirus lockdowns took effect.

In most markets, energy and financials were hit hardest. Some parts of the retail sector saw big losses, though others – such as online sellers – boomed. As an example, Australian online retailer Kogan’s sales more than doubled in March, while store visits at some of the largest malls were down by 50 per cent.

“One of the things I like to point out is that the market cap of Zoom is now larger than that of the global airline sector,” Anand says, referring to the videoconferencing platform, whose stock price has risen more than 140 per cent in the past year.

“And as we see economic strategy by governments globally moving from monetary to fiscal policy, this will also in itself create a higher degree of variability.”

China is different

They also warn against the dangers of extrapolating China’s experience of economic recovery to other parts of the world.

“China is not out of the woods yet either,” says Efstathopoulos. These comments take on even more significance now, as the coronavirus itself – not just the economic fallout – is threatening a second outbreak in the capital of Beijing.

He recalls positive sentiment around China’s retail sales back in April, but suggests it was premature.

“Production is recovering faster than demand, which has a higher risk of deflation or disinflation.”

The cultural differences in China, where the government has tighter control over the economy through monitoring and state controls than in other countries, is one factor here.
And the quicker increase in factory production, as indicated by China’s higher purchasing managers index of 50 versus less than 35 in Europe and UK, is another indicator.

“So can we extrapolate? It’s a question mark,” says Efstathopoulos.

But Anand emphasises they’re extremely cautious about broad recommendations in the current environment. Even in Asia, a region they’re much more positive about than others, he is cautious.

“It looks like Asia will be showing the highest level of economic growth over medium term, as the first region to come out of lockdown but also this notion of inter-dependence, with the growing level of trade within Asia.

“But the way different economies will emerge has the scope to suggest that inflation may surprise on the upside over the next two to three years.”

is senior editor for Morningstar Australia

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