Equities get a tailwind from Asia

The MSCI China index (the ETF ticker is MCHI) has returned over 14% year-to-date in dollar terms, vs just over 9% for the S&P 500. China has been 2019’s stealth trade, with steady gains in local-currency equity markets, bonds, and currency.

Overall emerging markets have blown away developed markets, although investors should discriminate: Brazilian and Turkish stocks have bounced back from a slump brought on by economic weakness, and have a long road ahead to recovery. China’s stock market tumbled under the threat of trade war. For all the banter about Chinese economic weakness, the world’s second largest economy is still growing over 6% a year.

I’ve been convinced that a US-China trade deal would emerge before the two countries passed the tripwire for a 25% tariff level, largely because Beijing is willing to sign a deal that would allow Trump to claim victory. By 2035, Chinese planners say, China will be the world’s largest economy and immune to American pressure, so why fight now? President Trump needs a victory, and China will hand it to him.

As optimism builds for a US-China trade deal, fears about a Chinese economic slowdown are dissipating as well. Europe’s stock markets rallied today, in part because companies who depend on Asian sales reported better-than-expected results. LVMH reported an 18% increase in profit for 2018 driven by a 15% increase in Asian sales. Estee Lauder stock rose by 14% after the cosmetics firm issued stronger guidance motivated in part by Chinese sales.

Chinese index returns reflect strong performance by financials (with Citic Securities and Huatai Securities in the top places), real estate (Country Garden Holdings and China Vanke), and China Petroleum (due to oil price recovery). Evidently, China’s monetary stimulus has raised earnings expectations for the financial sector and increased confidence in the property sector. Property comprises about 40% of Chinese household wealth, compared to only about 7% for equities. The Chinese government will do whatever it takes to keep property prices stable. I continue to like Chinese property companies.

There is a liquid emerging markets ETF (EEM), but investors might as well stick with China. The overall emerging markets index trades closely with China, for two reasons. The obvious one is that China is a very large part of the index, and the less obvious is that Chinese growth is a major driver of emerging markets growth globally. The chart below shows a very high correlation between the first Principal Component of the emerging markets universe and returns to the Chinese market (in this case the MSCI China ETF, MCHI).

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