Is the Chinese stock market in a bubble, or are the lofty valuations simply a reflection of the country’s superior growth prospects? Who better to ask than Mark Mobius, Franklin Templeton’s roving emerging markets expert. (The interview is courtesy of Franklin Templeton Investments).
Q: Is it time to take profits in the Chinese stock market? Is the current trend sustainable or is it due for a correction?
Mobius: There is no way anyone can predict whether a market is at its peak. No one can predict the market direction and a bear or bull market could start or end at any time. However, the good news is that bear markets are shorter in duration than bull markets and bear markets go down a smaller percentage than bull market increases. This is why one must invest with a long-term view. It’s true that the excess liquidity in China is sending the A market valuations higher and higher but since China’s capital account is still under control, this situation of expensive valuations could last longer than most could expect. The Chinese government has realized that the risks associated with an overheated stock market could be tragic and we believe that it will introduce more measures to contain the excessiveness. Having said that, we also believe that they would not like to see the stock market experience dramatic falls as the impact would not just be limited to the economy. There could be social and political implications as well.
The “A” share market has become highly speculative as small Chinese investors try to achieve returns beyond those available from bank deposits given that interest rates have been kept deliberately low in China. But the experience of Japan in the 1980s and early 1990s suggests that markets can benefit from investors’ bullishness for much longer than outside observers believe possible.
Having said that, the valuations of the “A” shares are definitely excessive. But these higher valuations are a reflection of both the higher perceived growth potential of the companies there and the current higher risk appetite investors have on Chinese securities. However, the law of investing in every market is the same. A bull market is followed by a bear market; the only catch is that no one can predict the timing of either. Moreover, with China recently allowing domestic investors to invest offshore, we expect to see funds flowing into the Hong Kong-listed “H” and “red-ship” shares which are trading at a significant discount to their “A” share counterparts.
Q: How would you compare the market outlook of China with other emerging markets?
Mobius: China looks attractive because it is the largest emerging market today and with its accession into the World Trade Organization (WTO), will also become a significant player in the global trade arena. With a domestic market of 1.3 billion people, China has been experiencing strong consumer expenditures, per capita spending, and retail sales growth, the effects of which will continue to boost the country’s economic recovery. The full economic potential in China is far from being reached today and therefore it is possible that the high growth of the Chinese region could continue. Thus, the country presents significant investment opportunities for investors.
We view the market outlook for emerging markets including China to be positive. While the Chinese market may have higher potential due to the reasons discussed above, we believe that many markets continue to warrant our attention.
Q: In addition, the quality control issue of products produced in China has been under the spotlight lately, would this be one of your factors to evaluate the company during your on-site visit?
Mobius: Quality control has always been one of the many criteria we evaluate when visiting companies.
Q: The coming 17th Communist Party of China (CPC) National Congress is scheduled on 15 Oct, any insights or view that you could share with us relating to the measure that would be introduced?
Mobius: We don’t expect the government to implement any measures which could have a detrimental impact on the economy. Thus, the continuation of gradual cooling measures is expected.
Q: Is your outlook different for ADRs/ETFs compared to H shares open to foreign investors or the A/B shares available to Chinese investors?
Mobius: Well, an ADR is essentially a certificate issued by a US bank representing a specific number of shares of a foreign company, thus theoretically the outlook for the respective ADR shares should be the same as the underlying foreign company. As for ETFs, they track the performance of an index or exchange and will thus trade in line with the market sentiment on that market. Thus, if investors are very optimistic about a market, the ETF tracking that market could trade at a premium; conversely, if investors are pessimistic, a discount can be expected.
Q: Where do you see opportunity? Are there certain sectors that are attractive or now unattractive?
Mobius: We see opportunities across the board. In line with our long-term, bottom-up investment strategy, we do not intentionally over or underweight any sectors. Thus, our sector allocations are a result of our careful and in depth analysis of individual stocks. However, relatively speaking, we have higher weightings in energy, financials and consumers, more because of their relatively attractive valuations.
Q: Do you expect any financial crash in China in the near term? 2008-2009?
Mobius: That would be impossible to predict. However, given China’s strong economic growth and fiscal position, I do not expect to see any financial crisis in China. Having said that however, it is important to note that some form of correction in the Chinese stock market cannot be ruled out as the market is currently trading at excessive valuations and has experienced rapid price appreciation.
Q: Do you think that the Chinese Growth could affect other Non-Asian Emerging Markets such as Brazil or Mexico?
Mobius: Yes and it has already been doing so. China’s strong growth, for example has increased the demand for commodities such as iron ore and oil, which are major exports for Brazil and Mexico, respectively.
Q: Implications of foreign exchange rates? (The dollar is weak and the U.S. interest rate cuts were considered a boon for foreign markets) Should investors be using options or doing anything else to mitigate risk?
Mobius: The best and safest way to mitigate against foreign currency risk is to diversify your portfolio globally. This provides a natural hedge. The use of options or any other similar instruments bring along with it additional risk, and thus should probably only be used by more experienced investors. In my experience however, the best defense to risk is to adopt a long-term view, diversify your investment, and carefully evaluate their options.