China Property Risks Small Relative to Global Capacity to Absorb
By Citi Global Wealth Investments
Global financial markets were rocked overnight with a highly correlated selloff across the world. Global equities fell about 2.0% with all regions and 10 of 11 sectors negative. US markets closed in the red with S&P 500 down 1.7%, Dow Jones -1.8%, and NASDAQ -2.2%. The catalyst was the well-telegraphed news that Chinese property developer Evergrande would not make loan payments yesterday (Sep 20).
At the time of writing (3pm HKT), Hang Seng Index is down 3.46% on Monday (Sep 20) trading. The Hang Seng Property Index dropped nearly 7% to a 52-week low. Markets in Mainland China, Japan and South Korea are closed due to public holiday.
To build more resilient portfolios, Citi analysts have long argued for diversification from idiosyncratic country risks. Regionally-diversified equity portfolios have a history of stronger results than “home-only” portfolios when a crisis hits. For global investors, it is important not to look backward at strong gains in markets, but forward when corrections present opportunity.
The initial selloff resulting from China’s regulations on the tutoring industry is fueled by margin deleveraging and fund redemptions, which is likely to be short lived. Between now and sustained recovery, however, there is likely to be a period of volatility, as investors assess impact on earnings. But looking out 1 year and beyond, Citi analysts remain convinced that China’s consumption and technological development could still offer attractive returns.
Just as we have seen a recent repricing of tech shares in the US, we have also seen a repricing of tech and consumer shares in China. This negative performance was driven by a broad tightening in credit and regulatory policies that Citi Global Wealth Investments (CGWI) identified in January when we reduced our China allocation down from overweight to neutral.
Citi analysts suspect that markets may be range bound in 2Q with some volatility from policy uncertainty, but this is a necessary process as investors get accustomed to a more normal policy backdrop. In summary, Citi’s analysis of sensitivities to rising US yields and to tightening Chinese credit conditions supports a neutral allocation in China, Korea and Taiwan equities, while remaining overweight in Southeast Asia.
