Asia can set tails wagging in Chinese Year of the Dog

Visitors to the East are fast made aware of Chinese traditions. New buildings in Hong Kong are designed by architects and ergonomists, with a helping hand from feng shui masters. 

These traditional practitioners of a metaphysical belief system, aiming to create an equilibrium between individuals and their surroundings, play a major role in shaping the territory’s unique cityscape. 

Elements of this mystical, semi-philosophical discipline are incorporated in the CLSA Feng Shui Index, predicting behaviour of Asian markets. As we enter the Chinese Year of the Dog, pharmaceutical and consumer stocks – representing industries related to wood – are looking healthy, while bad spirits could threaten banks, autos and other firms linked to metal elements. As the earth dog, whose zodiac sign beckons us, stands for loyalty, duty and protection, investors are reminded to put prudence ahead of aggression.

While advice from the CLSA brokerage has a humorous slant, there is no hiding the strategy behind it, reflecting China’s future role in global growth, coupled with a dampening of previous exuberance. Indeed the gung-ho gambling on the Hang Seng of the early 1990s has been replaced by a much more diversified investment strategy 25 years later. So much so that there is often a reluctance among high-end Asian investors to trust their own regional markets, preferring to scout lower octane but safer bourses in Europe and the US.

At the asset management arm of HSBC, still seen as Hong Kong’s leading bank, this topic of China versus the world is increasingly the subject of discussion with clients. Even outside the “Big Beasts of IT”, including Baidu, Alibaba and Tencent, good profitability can currently be bought cheaply, with a disciplined approach, believe the bank’s investment staff. 

Last year, HSBC oversaw Asian returns of 40 per cent for clients in dollar terms and profitability is improving further in 2018. Private investors are currently presented with a “very appetising opportunity in Asia”, believes Bill Maldonado, CIO Asia Pacific at HSBC Asset Management.

During 2016, when concerns about Chinese growth reached their peak, local clients started to distance themselves from China-related stocks, diversifying into defensive Asean economies of Malaysia, Thailand and Singapore. But these have now become expensive, leading HSBC to prefer northern opportunities in China, Hong Kong, Korea and Taiwan. Cyclical companies such as shipbuilders are particularly in focus.

Eyes elsewhere

This story is not easy to sell in Hong Kong. “Asian investors tend to have more globally diversified portfolios than European investors,” says Mr Maldonado, they have been investing internationally for longer and are loathe to change this. 

Now the bank finds itself on sticky ground, advising investors, already heavily weighted to the region through their business interests, to devote more assets to local opportunities. 

“We are telling people: your region is the most attractive in the world and you need more exposure at this time,” he says, believing clients risk missing investment gains on their doorstep.

It is the emerging market specialists such as Franklin Templeton which really champion the Asian growth story, allocating weightings of 30 per cent to Chinese equities, taking advantage of changing regulations in the financial sector, in addition to new economy opportunities. 

Open road

Paradoxically, despite the Communist Party’s increasing dominance, a more open economy is having a positive effect on trade and markets, especially through the Belt and Road initiative (BRI). 

Chinese investments through this geopolitical strategy are boosting south-east Asian economies, building railways, roads and ports. The rise in domestic labour costs, slowdown in potential growth and imbalances resulting from overcapacity in certain economic sectors are all prompting Chinese authorities to channel investments beyond national borders, according to Nikko Asset Management in Singapore. 

More than $30bn was invested in Asean by Chinese authorities and companies in 2015 and the same again in 2016, with $275bn in outstanding BRI plans, from which Indonesia in particular will benefit. 

“This creates jobs and infrastructure, helping developing economies to build their own manufacturing bases,” says Edward Ng, a portfolio manager at Nikko. “Chinese foreign direct investment into Indonesia has grown so much it can finance the whole current account deficit.”

Chinese banks, railways, construction firms and power generation companies are also likely to benefit from the BRI-led boom.

Structural changes and reforms, including the bankruptcy law, implemented during prime minister Narendra Modi’s stewardship of India, are also seen as positive for markets. Mihir Kapadia, CEO of Sun Global Investments, recommends infrastructure and commodity-allied industries, both in India and Hong Kong.  Yet India trails China in technological innovation. China is well ahead in terms of research laboratories cooking up new products and concepts for Western markets, say Templeton strategists.

There are clear risks to the Chinese success story. BRI projects are negotiated in the highest echelons of government for both parties. Changes in the elites or the system lead to increased political risk. Burkhard Varnholt, chief investment officer of Credit Suisse, points to unresolved conflicts and border disputes across Asia, which could raise their heads if economies falter. 

Create’s Amin Rajan warns of governance risks in “companies still in the process of adopting standards of business conduct that meet fiduciary requirements of Western institutional investors”.

But the sheer power of the region in terms of consumers, technological prowess, entrepreneurism and the growing wealth pool will keep China and its neighbours in the financial news, in both equity and increasingly fixed income. Moreover, the region’s portfolio managers have every confidence in being able to avoid the market’s dogs, whatever the name of the year.