The other week, a reader asked if he should sell his equities. He’d bought in March, made a nice return and presumably wanted to lock the profits in.
The first question I should have asked him is “How are you sleeping?” An investment portfolio is supposed to work towards getting you a better lifestyle in the future than you might have had otherwise. If worrying about that portfolio is messing up the life you have already, it is definitely time for a rethink. This is where wealth managers have value, by the way — they take the stress on for you.
The second question is “What do you mean by equities?” My thoughts on his next move would have rather depended on whether he had a portfolio of overpriced non-profit making US technology stocks or a neatly diversified portfolio that included European exposure, commodities and emerging market equities.
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Buy “anti-fragile” assets
However, the key point left hanging by the question was this: what on earth should an end-of-pandemic portfolio look like? One answer is “anti-fragile”, a term used by the analysts at Gavekal Research for assets that can cope with the volatility created by today’s political weirdness.
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What are these assets? The first thing to say is that they probably aren’t US equities. Expensive asset classes are by definition fragile, says Gavekal. There’s no wriggle room for things to go wrong for a stock already valued way above its long-term average.
They also aren’t US Treasuries — everyone’s go-to anti-fragile asset in the past. They are already expensive and the mix of supply disruption and demand stimulation means that inflation is more likely than not. There is nothing anti-fragile in that.
We must, then, look further afield. There are some obvious answers. There is gold (one of my favourites); alternative energy assets (not so much for their intrinsic value, but for the wall of cash governments are determined to chuck at them); and of course the properly cash-generative tech stocks (many analysts are happy to ignore the valuation issues simply because they are such an obvious hedge against new lockdowns).
I’d add in the UK, which is relatively cheap and in reasonable shape. But this is not a popular call at the moment.
China: marching to a different tune
One market that is popular — in that it keeps popping up in my inbox — is the Chinese equity market. It is “marching to a different tune” from the rest of us, says Gavekal, and thus counts as anti-fragile. When it comes to economics and markets, though, this different tune looks like it fits with what we used to think of as normal.
China’s real-time economic indicators are mostly back to pre-Covid levels. Industrial profits rose nearly 20% in July after a 40% decline in the worst months of the pandemic (January and February in China). Second-quarter GDP numbers were actually positive.
Look next to the bond market. Buy a ten-year Chinese government bond and you’ll get a yield of 3% or more. In a world of negative interest rates that feels close to miraculous. No wonder foreign investors are pouring in.
You can expect this sense of monetary normality to continue — for now at least. Christopher Wood of Jefferies, an investment bank, points to a speech made in June by Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission (CBIRC). China, he said, “values very much the normal monetary and fiscal policies we are practising now. We will not flood the economy with liquidity, still less employ deficit monetisation or negative interest rates.” Normal economic growth and reasonably orthodox monetary policy. Makes a nice change, doesn’t it?
So what of the stockmarket? The first thing to say is that despite the surge since March, it isn’t expensive. Relative to past earnings, stocks look fine. Relative to forecast earnings, they look pretty reasonable, particularly if you look outside the biotech and technology sectors. The second thing to say is that, while the Chinese economy makes up 16% of the world’s GDP and around 14% of the world’s exports, it still only makes up 5% of the world’s equity markets, despite those markets being home to some of the largest companies in the world by market value. The obvious examples are Tencent and Alibaba, companies it is hard to get through the day in China without using.
Everyone needs a China allocation
That’s likely to change, says Stéphane Monier, chief investment officer at Lombard Odier bank. He reckons that in the post-pandemic world everyone needs a “standalone China allocation” rather than one lumped into their other emerging markets holdings. China is constantly implementing structural reforms (regulators are increasingly shareholder friendly), reinforcing its global leadership and evolving into a “domestic-driven service economy” backed by homegrown technology champions.
We could think of China’s relationship to artificial intelligence today as the US’s was to space exploration in the 1960s. That may be something most of us will want to be invested in, particularly as China and the US become increasingly competitive in the tech field.
Not everyone is going to be convinced that holding any direct Chinese equities is something they want to do. Chinese monetary policy, economic activity and stock market valuations may be knocking around what we might consider normal for the pre-crisis West. Chinese politics are clearly not — and there is obvious risk in that.
If you do want to invest — perhaps as much as a hedge against the failure of the West to normalise as anything else — there are plenty of good fund managers in the space and this is a market so inefficient that they can really earn their money. In the five years to 2019, the median China A-shares manager made an annualised excess return of 6.3%. With many institutional investment funds staying out of the market “for fear of more anti-China moves from Washington in the run-up to the November election” says Wood, now isn’t a bad time to get in. I hold the Fidelity China Special Situations investment trust (LSE: FCSS). Other good funds include First State China Growth fund and Barings China Select fund.
• This article was first published in the Financial Times
