Financial crisis fears in China overblown – private bank chiefs

Helen Avery
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Euromoney asked the CIOs and strategists of the leading private banks: are you adding or taking away China risk in your portfolios?

Fan Cheuk Wan, CIO Asia Pacific, Credit Suisse Private Banking and Wealth Management:

We take a neutral position on China equities to balance structural reform benefits and credit default risks as the peak trust fund repayment period is approaching in June to August.

We do not see a clear resolution of China’s local government debt problems in the coming months, but equally do not expect a systemic crisis. Market fears of a Lehman-style financial crisis in China are overblown.

In response to weaker-than-expected economic data in the first quarter of this year, the Chinese government has quickly introduced targeted stimulus to stabilize growth. Further fiscal stimulus measures in the public infrastructure and social housing sectors are likely to support a tactical rebound in the China market in the coming weeks, but a sustainable market recovery requires more convincing progress in structural reforms to contain systemic risks.

Divergent performance between the winners and losers of structural reforms is expected to extend in medium term despite short-term rotation from the high-growth new-economy stocks to the bombed-out old-economy counters.

In contrast to many emerging economies, China has a sizeable current-account surplus, war chest of $3.8 trillion in foreign-exchange reserves and a largely closed capital account. With the world’s highest savings ratio at 51% of GDP and system-wide loan-to-deposit ratio averaging below 70%, China’s ample domestic liquidity should help mitigate the risk of a systemic crisis.

The low level of central government debt at 21.7% of GDP allows room for the central government to take on the debt of financially trouble local governments if the need arises.

To position for China’s prolonged deleveraging and economic restructuring, we favour structural growth themes and domestic reform beneficiaries in the internet, financial, healthcare and new energy sectors, and avoid exposure to the overcapacity sectors and small and medium-sized Chinese banks which are more vulnerable to shadow banking risks.

Burkhard Varnholt, head of Investment Solutions Group and CIO, Bank Julius Baer:

We are adding China, because there are clear signs of stabilization. Further recent economic data in China have been on the weaker side recently, but appear to stabilize at current levels.

While some easing of the growth dynamics had to be expected as a consequence of the ongoing reforms, the government is rather unlikely to tolerate a more severe economic slowdown. Therefore, the probability of additional fiscal or monetary stimulus measures has risen.

The recently decided reforms are also likely to have a positive medium- to longer-term impact on the profitability of Chinese corporations. Therefore, our allocation to Chinese equities within the emerging Asian equity exposure will be increased.

The ongoing reforms in China mean that defaults and de-listings of Chinese bond issuers will continue to take place. Thus, careful differentiation among Chinese bond issuers is needed. At this stage, we also keep our exposure to offshore Chinese renminbi (CNH) bonds as the currency is expected to appreciate again from the current levels.

Ben Pedley, regional head of investment strategy Asia, HSBC Private Bank:

We argue that the wide divergence in Asian equity market performance in 1Q cannot continue. Markets are too pessimistic about a slowdown in China and the perceived fragility in its financial sector. We now turn overweight on China equities due to extremely low valuations, and expectations of policy response to slower growth set the stage for equities to rebound.

John Woods, Asia Pacific fixed income head, Citi Private Bank:

We are overweight China risk and have been since late June 2013. We think a lot of China’s economic challenges are adequately and appropriately reflected in its price. There is no doubt growth is slowing which will bring a host of challenges to its banking system and property sector to name but two. But with equity valuations even through global-financial-crisis lows, we think investors are being compensated for the risks involved.

As/if synchronized G3 growth gains traction, we believe China will benefit from improving export performance and a likely acceleration in inward investment. Indeed, as US rates start to durably rise – a phenomenon to which domestic China is largely impervious – we suspect an equity rotation out of rates-sensitive southeast Asia will accelerate, with value-seeking flows benefiting north Asia in general and China in particular.

We do not underestimate the risks China faces, but we believe the economy enjoys sufficient flexibility to manage such risks. For example, investors should rightly be cautious of China banks if, for example, they believe reserves set aside for loan loss provisioning are insufficient for future asset impairment; that profit growth at the large banks is likely to turn negative; and that the state would be unwilling to step in and offer a back-stop degree of support if required.

But such assumptions are not our base case. Indeed, we believe the reverse to be true. As such, we suspect China’s deleveraging will continue to grind on for the next three or four years, with risk assets responding with sideways-to-positive momentum from current levels.