By Carolyn Cui
Many global investors are missing out on China's strongest
stock-market rally in years, the latest sign that a potential clash
with the U.S. over trade and currency policy looms over the world's
most populous nation.
As of Tuesday's close, the MSCI China index is up 11.6% this
year, making it the fourth-best performer among the 23 countries
tracked by the MSCI Emerging Markets Index. That index is up 9.8%
through Tuesday's close. China's early gains put the market on pace
for its best year since 2012, when its stock index rose 19%.
Yet many foreign investors say they are waiting to add to
Chinese investments, citing concerns about capital flight, mounting
debt and slowing economic growth.
China's economy last year expanded at a 6.7% clip, its slowest
in 26 years. President Donald Trump's threats to label China a
currency manipulator and reshape U.S. trade relations with China
have added political uncertainty.
China-focused stock funds have had outflows of $815 million in
2017 through Feb. 16, according to EPFR Global. That compares with
$7.6 billion that flowed into emerging-markets funds that include
China.
Should rising global tensions over trade and currency policies
spill over into financial markets, Chinese investments could be hit
hard, many investors say.
A confrontation with the U.S. isn't necessarily the most likely
outcome, many analysts say. But the risk of a clash between two of
the world's leading economies remains one of the most significant
sources of uncertainty when the global order is being recast by
political upsets such as the Brexit vote in the U.K. and Mr.
Trump's election in the U.S.
"China is the most likely source of global economic shocks over
the next two to three years," said Sharmin Mossavar-Rahmani, chief
investment officer of Goldman Sachs Private Wealth Management
Group.
Ms. Mossavar-Rahmani's primary concern about China is the
country's rapid debt buildup. China's reading on its total social
financing, a broad measure that includes bank loans and shadow
lending, surged to a record $545 billion in January, more than
double the previous month despite government efforts to rein in
lending.
Heading into last year, Ms. Mossavar-Rahmani said she didn't
expect China to have a hard landing in 2016 or 2017. Now her
assessment is that China is unlikely to avoid a financial crisis
over the next three years.
Western investors continued to pull back from China last year as
outflows persisted. China equity funds had $9 billion in
redemptions last year, while investors pulled $21.2 billion out of
those funds in 2015. By contrast, broader emerging-market stock
funds took in $20 billion in 2016, buoyed by an improving growth
and earnings outlook in much of the developing world.
China also continues to suffer outflows, albeit at a slower pace
since it tightened capital controls on corporations and individuals
late last year. In January, China's foreign-exchange reserves
dropped below $3 trillion as authorities sought to stem the
currency's decline.
Many investors are unnerved by the Trump administration's
aggressive stance toward China.
"It's a known unknown," said David Semple, portfolio manager at
the $1.1 billion VanEck Emerging Markets Fund. "It's not just the
actual impact of what occurs at the end of the day; it's the fact
that there'll be headlines and tweets that will make people
concerned."
As a result, foreigners are light on Chinese stocks. Just 18% of
the 120 biggest global emerging-market funds held more Chinese
stocks than the benchmark emerging-markets index at the end of
January, according to Copley Fund Research.
Investors also worry that China's problems could reverberate
broadly across the developing world. China is integral to the
global supply chain, with many components made and assembled there
before being shipped to other countries.
"Clearly, any sort of trade protectionist policies emanating
from the new U.S. administration would have a negative impact on
overall global trade," said Prakriti Sofat, an emerging-market
portfolio manager at Goldman Sachs Asset Management, which has an
underweight bias toward China.
Any further slowdown in Chinese growth would also hurt
commodity-exporting economies such as Brazil, Russia and South
Africa, said Paul McNamara, an investment director at GAM.
Still, some on Wall Street are starting to think the worst may
soon be over. In a report titled "Why We Are Bullish On China,"
Morgan Stanley said the country's stocks could outperform the rest
of emerging markets in the next decade.
"China will be able to avoid a financial shock," the report
said. It cited China's high savings rate, current-account surplus
and its still high level of reserves.
Calamos Evolving World Growth fund bought Chinese industrial and
financial stocks during the fourth quarter last year. Nick
Niziolek, co-chief investment officer at Calamos Investments, has
raised his fund's allocation to China to 25.6% from 20.4% since the
end of last year.
Mr. Niziolek said that China bears are overlooking the
attractive valuations and some of the more encouraging economic
indicators, like stronger manufacturing and inflation data.
"Where there is risk, there's where the opportunities are," he
said.
Write to Carolyn Cui at carolyn.cui@wsj.com
(END) Dow Jones Newswires
February 21, 2017 18:58 ET (23:58 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.