The market’s herd-like behaviour has been on full display in the past few weeks. After becoming overly bearish on China, global equity markets rallied when the Chinese government surprised with economic stimulus measures.
Big moves followed.
This columnist’s preferred China exposure, the iShares China Large-Cap AUD ETF, is up almost 30% in a month.
Resource stocks rallied on expectations of stronger Chinese growth boosting commodity prices. The SPDR S&P/ASX 200 Resource Fund rose 11% in a month.
At a company level, Rio Tinto is up 14% in over one month, BHP is up about 12% and Fortescue Metals Group is up almost 15%. Some commentators argue a major sector rotation is underway from overpriced local banks to resources.
Who knows if this rally will be sustained. I suspect the market is ahead of itself on hopes that China can meet its annual growth target of around 5% in 2024.
Chinese stimulus measures announced in late September are substantial. But the extent of structural problems in its property market – and the impact this has on Chinese consumption and economic growth – will take years to fix.
Basing investment decisions on China’s short-term economic prospects is dangerous. The lack of transparency creates too much uncertainty.
Three responses are required.
First, focus on what matters most: company valuations.
Second, take a long-term view, preferably at least seven years.
Third, view Chinese equities exposure within the context of a diversified portfolio.
On that score, there’s merit in cautiously adding China-related equities exposure to portfolios, with caveats. I wouldn’t rush to buy just yet. After quick moves of this size, expect some type of retracement.
My favourable view on Chinese-related equities, which includes emerging-market equities and local resource stocks, is not based on the latest news.
Readers will recall I suggested on September 11 to rotate from Indian to Chinese equities in 3 rotation ideas from overvalued to undervalued assets.
The Global X India Nifty 50 ETF, a key barometer of large-cap Indian stocks, is down about 1% over one month. As mentioned, the iShares China Large-Cap AUD ETF is up 30% in that time. That portfolio rotation idea was well-timed.
Chart 1: iShares China Large-Cap AUD ETF (ASX: IZZ)
Source: Google Finance
In early September, I outlined two ideas in copper and lithium to benefit from commodity weakness. The Global X Copper Miners AUD ETF is up 11% in the past month. The Global X Battery Tech and Lithium ETF hasn’t done as well, up 2% in that period, but remains an interesting way to play a lithium recovery.
The point of this analysis is not to highlight winning ideas. A few good weeks have less relevance for long-term investors. We want ideas that deliver substantial gains as assets recover over long investment cycles.
China-related equities could fit the bill. It’s amazing how last decade’s loser can become this decade’s winner and vice versa – another reason not to follow the herd.
Although recent gains impress, the iShares China ETF has an annualised return of just 1.1% over 10 years to end-August 2024. The S&P 500 Index in the United States has returned 16.31% on average annually in that period.
Put another way, Chinese equities have massively underperformed for years. Readers know I like searching for badly-out-of-favour assets the market gives up on. A few weeks ago, that was Chinese equities.
To avoid repetition, I won’t cover the iShares China ETF. Instead, I’ll consider two other ways to benefit from stabilising China growth.
First, a caution.
No recoveries occur in a straight line. A recovery in China, should it occur, could be two steps forward, one-and-a-half steps back. Expect plenty of volatility and doubters along the way. This is not an idea for inexperienced or risk-averse investors, or those with a short-term horizon.
For most investors, Chinese equities exposure will only be a tiny fraction of their overall portfolio, held within the emerging-markets allocations (typically 5-10%, depending on an investor’s risk preference).
- SPDR S&P/ASX 200 Resources Fund (ASX: OZR)
Readers know I have a favourable long-term view on commodities, principally due to supply factors. Key minerals such as copper are becoming harder to find, costlier to mine and subject to greater disruptions such as labour strikes.
Market focus on Environmental, Social and Governance (ESG) concerns, particularly for fossil-fuel projects in oil and coal, is discouraging investment in new projects or extensions of existing ones. All this points to greater challenges on the supply front for commodities this decade, and thus more support for commodity prices.
Not all commodities, of course, will benefit. But it looks like worsening supply shortfalls this decade will coincide with firmer demand as the global economy improves, particularly if China gets its act together.
OZR provides exposure to 45 of the largest resource stocks on ASX. It’s worth noting that BHP Group, a stock I like for long-term investors, comprises 40% of OZR by weighting. Clearly, a bet on OZR is a bet on BHP. Beware duplicating BHP exposure through OZR if you already hold that stock directly.
OZR has a 10-year annualised return of only 6.8% to end-August 2024. Since inception in 2011, OZR has delivered a paltry 2.7% annually.
If I’m right about the commodity super cycle and Chinese growth, the long-term underperformance of OZR will reverse this decade.
Chart 2. SPDR S&P/ASX 200 Resources Fund
Source: Google Finance
- Vanguard FTSE Emerging Markets Shares AUD ETF (ASX: VGE)
Late last year, I outlined the case for higher exposure to emerging markets in 2024 in Timing right for cautious look at emerging markets.
VGE is up about 8% over one year to end-August 2024. But over 10 years, VGE has a paltry annualised return of 5.25% after fees.
Emerging markets should benefit from strong regional growth this decade. If it occurs, stabilising Chinese growth will be good for commodity prices and commodity exporters in Asia. Improved Chinese growth also bodes well for regional growth and trade opportunities for other Asian nations.
It’s a stretch to base an investment in emerging-market equities on some surprise good news from China to stimulate its economy. My interest is based on the long-term underperformance of emerging-market equities compared to developed-market equities, and attractive average valuations in the region.
VGE provides exposure to 5,934 emerging-market equities. Almost half of the ETF is invested in China and Taiwan equities, with another quarter in Indian equities. The rest is spread mostly between equities in South East Asia and Latin America.
The average Price Earnings (PE) multiple in the ETF is 15 times, despite a quarter of the fund being invested in technology companies.
Chart 3. Vanguard FTSE Emerging Markets Shares AUD ETF
Source: Google Finance
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 2 October 2024
