Is the China stock sell-off cause for concern?

Specific stocks and industries have been hit after China tightened regulatory policies in several sectors, including technology and for-profit education.

We view the regulatory news as one of the growing pains China is experiencing as it transforms from a closed economy into a more open one. While the country is still under communist rule, it has steadily embraced key elements of capitalism over the past 40 years. More regulation across industries, while disruptive and volatility-inducing over the short term, can be viewed as an important step in the country’s effort to mature.

These news shocks and across-the-board selling can create buying opportunities for investors who want to position for the economic growth of China and developing markets. We think that growth story remains intact.

The long-term case for investing in emerging-market equities remains strong. China is expected to dominate the global economy in the coming decades, surpassing both the U.S and India in GDP by 2050.¹

In addition, China currently represents nearly 18% of world GDP but only 5% of world market capitalization. We expect investors to pay more attention to emerging markets as China becomes an increasingly dominant player on the world stage.

Source: World Bank Group, MSCI. GDP data as of 12/31/20, market cap data as of 6/30/21.

The recent regulatory headlines have only exacerbated the underperformance of Chinese equities (and correspondingly, emerging-market equities) versus the rest of the world since the start of the year.

We attribute the softness in Chinese equities to a relatively less attractive economic growth picture versus the rest of the world. First, China’s Purchasing Managers' Index (PMI), a key gauge of economic growth, looks to have peaked in May, while other major economies such as the United States and eurozone have continued to climb. This may reflect the rise in COVID-19 cases in China, as well as policymakers’ efforts to pull back on stimulus to avoid the boom/bust cycles that have been associated with the country for decades. 

Meanwhile, earnings estimates—the other key input we use to gauge relative attractiveness across regions—continue to climb higher for emerging-market equities, with year-over-year earnings growth of 44% penciled in by analysts for 2021.²

This mixed picture, with the economic backdrop slowing yet earnings looking robust, leads us to a neutral view on emerging-market equities in Market Intelligence. We continue to prefer a quality growth bias outside the United States broadly, emphasizing secular growth companies with cyclical earnings upside. This translates to a preference for the consumer discretionary, industrials, and technology sectors overseas.   

As the saying goes, "it’s always darkest before the dawn." While we don’t know how long the sell-off in Chinese equities will last, we believe that ultimately the risks will be fully reflected in the price, creating a buying opportunity. We continue to advocate for emerging-market equities as a portion of a balanced portfolio and will continue to monitor PMIs, earnings, and regulatory risks as the key inputs to our view.    

1 International Monetary Fund. 2 FactSet, as of 6/30/21.