On any given day, even in the midst of a roaring bull market, you’ll see headlines about lurking problems that could tank your portfolio if you’re not careful.
In recent weeks, the gyrations of Chinese stock markets have provided plenty of headline fodder. The Shanghai Composite index staged a breathtaking 60 percent run-up between Jan. 1 and June 12.
Most of that gain occurred after March 5 as Chinese investors piled into stocks, unconcerned about fundamental weakness in many of the companies whose shares they purchased.
Perhaps unsurprisingly, the party came to an abrupt end, with the index skidding 25 percent between June 12 and July 15. In recent weeks, the headlines about China have mainly focused on the risks associated with the sharp decline.
American investors have a love-hate relationship with Chinese stocks. On one hand, a fast-growing market is appealing. But on the other hand, heavy government intervention, along with not-so-trustworthy financial reporting, doesn’t inspire confidence.
Despite the current fear factor, investors should keep China’s market moves in perspective, says Jared Kizer, chief investment officer at Buckingham Asset Management in St. Louis.
He cites data from Bloomberg showing that China’s share of world market capitalization weighs in at only 3 percent. That’s far less than most Americans would assume. Not only is it dwarfed by the 50 percent share the U.S. maintains in world market capitalization, but it’s also smaller than the U.K., Japan and Canada.
“People are generally surprised that the China number is that small,” Kizer says. “If they just bite on the hook of the news story, they assume it’s got to be a huge portion of the world’s equity market, and that shows it’s really not.”
But Kizer emphasizes that because of China’s significant role in the world economy, its markets and gross domestic production can’t simply be dismissed. Any investor who holds shares of large, multinational companies is almost certain to have some kind of China exposure. From that perspective, he says, news about China’s economy is relevant to U.S. investors.
“The economic piece of the pie is much bigger than the equity market cap,” he says.
However, Kizer says investors should look beyond the issues of China’s market capitalization or its gross domestic product, which the World Bank estimates at $10.36 trillion. The bigger issue for investors is understanding how stocks from China, or any other country, fit into a diversified portfolio. In addition, he says, investors should understand that market swings are routine occurrences.
“When you start looking across these individual countries, whether they are developed or emerging markets, it’s far from abnormal to see a gigantic move in a country’s equity market over the course of a year,” he says.
Several data companies track market performance of countries and regions around the globe. While most retail investors don’t analyze those numbers closely, or at all, many professional asset managers do. It’s not uncommon, Kizer says, to see a large spread between the best- and worst-performing countries in a single year.
“There will be a handful of countries every year that have big movements in markets, on the both the positive and negative sides,” he says.
Brendon Jenks, founder of Wealth Renovators in Overland Park, Kansas, also advises clients to take volatility in stride.
“In my last quarterly newsletter for my clients, I reminded them of two lessons to learn from the markets in response to activities in Greece and China,” Jenks says. “First, markets are behaving themselves. By definition, they are volatile. Investors shouldn’t be overexposed to a single asset class, nor ignore the return potential that comes from all of them.”
Jenks also reminds clients that returns come from the market itself, not a fund manager who gazes into a crystal ball and predicts the future. China, classified as an emerging market, is included in the portfolios of many investors seeking growth. Like any asset class, emerging-market stocks will have good and bad years.
Jenks uses a strategy of broad diversification in client portfolios. The idea is that uncorrelated assets can smooth returns, with better performers mitigating the effects of laggards.
“Emerging-market stocks add good diversification and return premium to the portfolios,” Jenks says. “In the last 15 years, they lost big in years like 2000, 2008 and 2011. But they were also the highest-return asset categories from 2003 through 2007, in 2009 and in 2012. Because they are so volatile, we keep exposure to them in the long-growth portfolio relatively low, at about 5 percent.”
Emerging markets have historically delivered higher returns than developed markets, but, as Jenks notes, those returns come with greater volatility. It’s impossible to have one without the other.
Stephanie Mackara, principal wealth advisor at Charleston Investment Advisors in Charleston, South Carolina, has a similar investment philosophy as Kizer and Jenks. She, too, uses emerging-market funds as part of a broad asset-allocation strategy.
“We certainly need to keep a cautious eye on China, but also need to keep in mind it is an emerging-market economy,” she says. “There is a lack of stability that most emerging economies exhibit. What we have seen over the past several months should remind us that where there is great opportunity, there is great risk.”
Kizer says risk-and-return issues come up frequently, and they are relevant to investors’ decisions about Chinese stocks or any other asset.
“Inevitably, people will ask: ‘Can I have great returns without having to tolerate those losses?’ It’s very, very difficult to consistently time anything, and that’s true for individuals and professional investors,” Kizer says. “The notion of having the upside, but not taking the downside, is incredibly difficult to execute in practice.”
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Why Investor Worry About China Is Way Overblown originally appeared on usnews.com
