China’s economy is continuing its winning ways, growing 6.9 percent in the second quarter on a year-to-year basis and expanding more than three times as fast as the U.S. economy.
Still, it’s not all good news for the lynchpin of the Pacific Rim.
China faces a staggering debt problem, which led to Moody’s downgrading the country’s credit rating earlier this month. A big part of that problem are China’s state-run companies, which have racked up heavy debt to build roads, invest in new companies and fatten up market investment portfolios. China’s corporate debt rose by 170 percent of country GDP last year, about twice the amount of other G-20 countries. Nine years ago, that debt level was 100 percent of GDP.
“The latest Chinese GDP report continues a string of strong and steady economic growth, at least according to the official data,” says David Twibell, president of Englewood, Colorado-based Custom Portfolio Group. “Setting aside the fact it’s generally a good idea to take China’s official releases with a grain of salt, the underlying concern I have about the Chinese economy is that much of its growth is being fueled by massive credit expansion.”
[See: Chinese ETFs: 9 Ways to Play the Middle Kingdom.]
Twibell says that Chinese debt levels are “skyrocketing” and speculation is running rampant in many sectors of the economy, including the housing market that has seen massive price increases. “China’s government is walking a very thin tightrope trying to reign in speculation and still promote growth, and there’s no guarantee they will succeed,” he says. “In fact, if history is any guide, debt-fueled speculative bubbles tend to end very poorly and there’s no reason to believe this one will be any different.”
China ETFs are strong. Even so, debt pressures aren’t holding back the stock market performance of China funds.
The two largest China exchange-traded funds are going gangbusters in 2017. iShares China Large-Cap ETF (ticker: FXI), with $3.16 billion in assets, is up 14.9 percent for the year, while the iShares MSCI China ETF ( MCHI), with $2.46 billion in assets, is up 25.5 percent.
Will that outstanding performance continue? Probably, although the jury is still out on how long it will last.
“Chinese growth once again surpassed expectations in the second quarter, growing 6.9 percent year-on-year, unchanged from the first quarter,” says Craig Botham, emerging markets economist at Schroders. “This should ease fears over the ongoing credit tightening in China, though we still expect a growth impact to come through in the second half of this year.”
Botham says a key contributor to the growth surprise was stronger-than-expected industrial production, at 7.6 percent, up from 6.5 percent in the previous month.
“Breaking the data down shows an acceleration within broad manufacturing, and within some but not all raw materials sectors,” he says. “So, this does not seem to be a growth performance entirely reliant on old China. This raises the upside risks to our forecast for 2017 of 6.6 percent growth; while we still expect real estate and infrastructure to slow, it seems increasingly likely that manufacturing may be able to compensate.”
[See: 13 Stocks to Buy to Bet on China.]
Other high frequency data has also surprised to the upside for China this month, with both retail sales and fixed asset investment beating expectations. “Arguably there are base effects at work but it is hard not to see this as a sign of resilience,” Botham says. “Within retail sales there was a large jump in particular for communication appliances (from 5.1 to 20.1 percent on a year-to-year basis), with most other subcomponents weakening. Jumps in this series tend to be short-lived, so it will be interesting to see if broader retail sales can maintain momentum in the months ahead.”
China is a powerhouse. China’s economy is the second-largest in the world and generally deserves a place in most investment portfolios. “While there are many mutual funds and ETFs that invest directly in Chinese stocks, we tend to prefer funds that cast a broader net and include a cross-section of emerging Pacific Rim economies,” he says. “ETFs like the SPDR S&P Emerging Asia Pacific ETF ( GMF) and iShares MSCI All Country Asia ex Japan ETF ( AAXJ) are both good options.”
Furthermore, now that MSCI has given the approval to include Chinese A-shares in its indices, Chinese stocks “should benefit from a steady flow of foreign money over the next several quarters,” says Charles Sizemore, a portfolio manager on Covestor, a Boston-based online investing company.
“All of this bodes well for Chinese stocks over the next six to 12 months,” Sizemore says. “It does look like China is enjoying a recovery, and there are no immediate headwinds.”
Money managers are quick to point out, though, the GDP growth doesn’t always translate into stock market growth. “Although we are positive on emerging markets, where China accounts for the largest country weighting at 28 percent, economic growth historically has a low correlation with how a stock market performs,” says Keith Lerner, chief market strategist at SunTrust Advisory Services in Georgia. “This is because other factors, such as valuations, earnings, inflation, interest rates and policy tend to play a greater role.”
Despite China’s economy growing significantly faster than the U.S. over the past 10 years, the MSCI China index has a total return of 45 percent, less than half that of the U.S.’s return of 99 percent, Lerner says.
“That said, we maintain a constructive view on China’s macro outlook, though expect a bumpy path forward,” he says. “We anticipate that the Chinese economy will continue to gradually decelerate toward a lower, yet less-risky and more sustainable growth trend in the coming years.
Lerner recommends investors focus on broad-based emerging market ETFs as the core for any emerging market exposure.
[See: 10 Great Ways to Buy Emerging Markets.]
“China accounts for more than a quarter of the index already, and there are also exposures to Asia, such as South Korea and Taiwan, which together also account for about 27 percent of the MSCI Emerging Market index,” he says. “India, which is growing faster than China, accounts for almost 9 percent. We believe for a core position, a broad-based emerging market ETF provides greater diversification as any single country tends to have higher risks.”
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Should I Invest in China? originally appeared on usnews.com
