White paper contributed by Tina Byles Williams and Adam Choppin of FIS Group.
The macro environment in Q3 (and for much of 2018) has been dominated by policy divergence: whereas fiscal stimulus buoyed the U.S., Chinese growth weakened as a result of the escalation trade war combined with Beijing’s attempts to constrain credit growth. This policy divergence has produced a powerful tailwind for the U.S. dollar and U.S. equities and corresponding headwinds for global equities.
In Q3, global markets were mostly flat, except in the U.S. (+7.4%) which saw a continuation of the final melt up in risk assets we forecasted last quarter. The USD continued to gain some ground globally, but not as uniformly as we saw in Q2 with the CAD and CHF rebounding against the USD modestly (+1.8% and +1.7%, respectively) in Q3 while the EUR was roughly flat (-0.5%). The best performing market among EM or DM country constituents was Thailand (+13.6%), which entered Q3 as our highest conviction max overweight position. On the downside, the worst performing major market — apart from Turkey (-20.7%) — was China (-8.4%).
Within the Chinese equity market, sentiment reversed in a hurry for the “New China” vs “Old China” theme. The previously hot performing Chinese tech stocks in particular took a tumble with Tencent (-17.7%), Alibaba(-11.2%), JD.com (-33%), and Sunny Optical (-38%) leading losses. Chinese health care (-17.9%) and consumer staples (-7.8%) also sank alongside the rest of the New China segments. Meanwhile, Old China sectors, such as other high beta and highly liquid segments of the market including China’s large state owned banks, Chinese industrials, energy, and telecom stocks, were all positive during the quarter. Excluding the New China stocks, the MSCI EM index would have gained +1.9% during Q3, and Old China +1.3%, all largely in line with the non-US developed markets (EAFE).
For the big liquid Chinese consumer/tech stocks, including the four leading Q3 detractors of the MSCI China mentioned above (Tencent, Alibaba, JD.com, and Sunny Optical), these price declines do not seem to have emanated from speculators or a new class of “China Bears”, but largely from sales by existing investors, as short interest margins actually declined on average during this period. If price declines were led by short-sellers, one would also have expected to see more pressure on the high beta, liquid Old China equities, but these held up well. Meanwhile trading volumes were well within the recent ranges for these stocks. Together we can conclude that instead of a wholesale dumping of the New China theme, when sellers trimmed exposures to these stocks in Q3, buyers stayed on the sidelines until they could average down their cost basis. The dual concerns of a cooling Chinese economy and the trade war with the U.S. are the most likely leading contributors to this chilling of enthusiasm for the New China theme (albeit, not our own). While growth is slowing, perhaps even more so than the official GDP numbers indicate, the consumption growth to which the New China stocks are principally exposed, appears to continue apace as the Chinese economy restructures.
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