In a world a bit short on growth, the Chinese secular growth story in recent years – particularly in the consumer space – has delivered returns that were largely justified by the innovative business models that delivered them. When stock fundamentals start going soft, however, as they did this year in the China Consumer Discretionary sector, price momentum on its own represents a danger signal. This high-flying sector, stuffed full of mega-cap names, is off nearly 20% YTD.1
Consensus to Crowded to Dangerous
Toward the second half of 2020, China stock prices were rising, and the earnings base was at least stable – which was seen as tolerable in a pandemic economy. While some may have quibbled with the valuations at that time, investors at least had to respect the earnings delivery – they continued to crowd into this trade. But, as we got into early 2021, the divergence of stock prices and EPS estimates began to flash a clear warning sign in our AQE models (see Figure 1). Despite the divergence, for several months prices continued to power upward even as earnings began to wobble. By the end of Q1, the earnings wobble had become a waterslide – and had begun to do some real damage.
Figure 1 : Decoupling Leads to Dramatic Price Action
As quantitative investors, our work is heavily focused on keeping a balance between the various elements that drive markets. We use price momentum, but we want it to be supported by earnings. Even though value is an anchor in our process, we happily buy growth names if they are justified by profitability. If fundamentals start to fade, our signals tell us to adjust our positioning – and we are nimble in doing so.
At the beginning of the year our alpha scores had turned neutral or negative on these high-flying China Consumer Discretionary names in virtually every component, and we successfully averted losses to our portfolios. Indeed, our preferred stocks this year in the consumer space (autos, sports apparel, robotics) generally managed to avoid the selling pressure, leading to very strong overall portfolio outcomes (see Figure 2).
Figure 2 : AQE Alpha in the China Consumer Discretionary Sector
We claim no great regulatory predictive power. That said, however, we believe that any equity valuation should reflect some degree of regulatory risk – especially in emerging markets, where there may be limited legal or legislative review of regulatory actions. Diversification is the EM investor’s best friend here, and is a key tenet of AQE portfolio construction.
Our lack of precise foresight also extends to determining an entry point in a depressed China equity market. We don’t yet see a balance between better valuation and supportive fundamentals, and the price action in our momentum signals suggests the risk environment has not stabilized. Patience is usually rewarded, even if you miss the first leg of a rebound
What We Do Like in Emerging Markets
In terms of country allocation, we are slightly below benchmark in China. Our overweight markets are mainly the other Asian heavyweights, Korea (where we like the Consumer names) and Taiwan (IT and Financials), but we have also built up a solid position in Russia (Banks and Steel). In China, we like the Pharma companies and the Energy names (plus some Apparel and Auto Retailers within the discretionary sector).
1YTD as of July 31, 2021. MSCI China is down 13%; MSCI Emerging Markets ex China is up almost 10%; and MSCI World is up 15%.
For use in EMEA: The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The views expressed are the views of Active Quantitative Equity through August 5, 2021, and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investing involves risk including the risk of loss of principal. Quantitative investing assumes that future performance of a security relative to other securities may be predicted based on historical economic and financial factors, however, any errors in a model used might not be detected until the fund has sustained a loss or reduced performance related to such errors.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
The trademarks and service marks referenced herein are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
This website is intended for persons resident in Australia. State Street Global Advisors, Australia Services Limited ABN 16 108 671 441, AFSL Number 274900 ("SSGA, ASL") is the product issuer. State Street Global Advisors, Australia, Limited (AFSL Number 238276, ABN 42 003 914 225) (“SSGA Australia”) is the Investment Manager. The material on this website is general information only and does not take into account your individual objectives, financial situation or needs.
You should seek professional advice and consider the Product Disclosure Document (PDS) and target market determination, available at www.ssga.com, before deciding whether to acquire or continue to hold units in the Funds.
You can access our PDS online or by calling us. The offer made in our PDS is available to persons receiving the PDS within Australia and applications from outside Australia will not be accepted. Past performance is not a reliable indicator of future performance. Investing entails risks and there can be no assurance that State Street Global Advisors will achieve profits or avoid incurring losses.
Investing involves risk including the risk of loss of principal. This material should not be considered a solicitation to apply for interests in the Funds and investors should obtain independent financial and other professional advice before making investment decisions. There is no representation or warranty as to the currency or accuracy of, nor liability for, decisions based on such information. Performance quoted represents past performance, which is not a reliable indicator of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted.