Chinese stocks approaching bear market territory

Escalating trade tensions have hit Chinese and Asian equities hard. But long-term investors shouldn’t give up quite yet.

China’s main stock market index, the Shanghai Composite, is teetering on the edge of bear market territory.

Despite being slightly up on the day on Friday (June 21), it is down by 19.3 per cent from its January highs, just shy of the 20 per cent decline that would qualify it as a bear market.

This week in particular saw Chinese shares take a painful hit, with the Shanghai index closing down by around 5 per cent over the period. Hong Kong’s Hang Seng Index (on which a lot of mainland Chinese firms are listed) also ended the week down by 3.4 per cent.

While certain domestic factors in China, such as monetary tightening, have squeezed Chinese domestic listed shares, the driver behind the market’s poor performance is the escalation of trade tensions between the US and China.

At the start of the week, the US announced that it would hit China with an extra $200 billion worth of tariffs in response to China’s retaliation to the US’s initial tariffs on Chinese imports. Further retaliation from China, the US said, would provoke a further $200 billion worth of import charges.

The increased tension also pushed down share prices across the region. The Vietnam Ho Chi Minh stock index dropped by 4.6 per cent over the week, while Japan’s Topix index closed 2.2 per cent down.

A recent study by UBS Group AG found that Asian stock markets are pricing in a 20 per cent possibility of a more serious trade war. According to the report, escalation of tensions between China and the US could see 30 per cent wiped off Asian markets.

However, the study’s authors are not expecting the worst-case scenario. ‘If our base case plays out, and calm is restored, current sentiment is likely pricing in too harsh an outcome,’ they note.

Should investors be worried?

International investors surveyed by Bank of America Merrill Lynch recently placed a prospective trade war at the top of their worry list.

Likewise, Nomura Holding’s June investor survey found that 68.6 per cent of Japanese-focused investors believe ‘international affairs’ will be the top factor affecting the stock market over the next three months, up by 3.7 per cent from March’s survey.

However, investors shouldn’t react too hastily. For investors prepared to ride out China’s volatility, the country is still a strong investment prospect, providing superior growth.

Laith Khalaf, senior analyst at Hargreaves Lansdown, says: ‘China is undeniably an exciting investment opportunity, but its stock market should be expected to be volatile, and will be subject to the yin and yang of global economic confidence.’

According to Oliver Smith, a portfolio manager at IG: ‘The market could easily rebound, and the iShares MSCI China A ETF (CNYA) which is listed in London, is a good way to play this.’

Smith also recommends Fidelity China Special Situations as a way for long-term investors to benefit from a rebound in sentiment. ‘It is around 18 per cent geared, with substantial allocations to tech and the consumer, while the discount has widened to -14 per cent from a one-year high of -9 per cent,’ says Smith. Over the past five years the trust, a Money Observer Rated Fund, has returned over 200 per cent for investors.

However, says Khalaf, for those wishing to mitigate China’s volatility, ‘it may be best to get exposure though a broader Asian fund like First State Asia Focus.

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