More quantitative easing, China style
March 16, 2016
In the latest 2016 effort to help its economy, China universally cut its reserve requirement ratio (RRR) by 50 basis points on March 1. The effect of this action was the release of about 680 billion renminbi of liquidity into the banking system to stabilize growth.
As discussed in our Insight in late 2015, we expected the People’s Bank of China (PBOC) to continue the use of monetary easing tools to maintain stable growth and low costs of funding in a continuation of what we called "quantitative easing (QE), China style." We therefore believe this recent move should not be considered overly surprising.
The timing of the current cut reflects:
- An emphasis on policy easing prior to the National People’s Congress (NPC) meetings scheduled for March 2016
- Maintenance of financial stability and an effort to keep interbank rates stable
- Further room to ease, with the currency stabilized in the near term
More monetary adjustments are likely
Broad economic growth continues to be divergent in China, with overcapacity weighing on investments, and a consumption-driven industry the relative outperformer. Key concerns remain about asset quality risks. Hence, we expect “QE, China style” to continue, as additional liquidity is injected to ease the interest burden ratio for both local governments and corporates, especially state-owned enterprises.
What does this mean for equity investors? In the near term, market sentiment may get a boost from NPC policy announcements, but there are longer-term concerns about both macroeconomic growth and fundamental earnings.
The charts below may help investors focus on a broader look at China’s equity markets, and they reflect our current views on both valuations in general and areas of potential opportunity.
From a big-picture perspective, with the MSCI China Index trading at a 9.4x forward price-to-earnings (P/E) ratio, compared to a 10-year average of 14.1x, valuations still appear attractive to us (see Chart 1).
Chart 1. Valuations appear attractive
Chart is for illustrative purposes only.
Source: Bloomberg, data as of Feb. 29, 2016
However, given the continued risk of earnings downgrades and erosion of return on equity, we remain cautious as we await earnings results later this month, and as we assess additions to portfolio holdings that are trading, in our view, at a meaningful discount.
While volatility presents opportunities, investors, of course, need to assess the quality of each company, especially examining them for corporate governance risks. We still see opportunities in domestic demand and in local consumption-driven sectors. One particular area of interest is the tourism and lifestyle spending trend, which is highlighted in Chart 2.
Chart 2. Aggregate outbound tourists over time
Chart is for illustrative purposes only.
Source: China National Tourism Administration, data as of Dec. 31, 2015
In this latest policy action to cut the reserve requirement ratio, central bankers didn’t offer any explanation. This leaves us to rely on our expectations, which — as noted above — include a call for additional policy steps in the future. While we will consider the influence such steps may have on the real economy, our focus will remain on maintaining a portfolio of holdings that we believe can stand on its own and deliver competitive, long-term performance despite changes in central bank policy.
The views expressed represent the Manager's assessment of the market environment as of March 2016 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting delawarefunds.com/literature or calling 800 362-7500. Investors should read the prospectuses and the summary prospectuses carefully before investing.
IMPORTANT RISK CONSIDERATIONS
Investing involves risk, including the possible loss of principal.
Past performance does not guarantee future results.
International investments entail risks not ordinarily associated with US investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations. Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
The MSCI China Index captures large- and mid-cap representation across China H shares, B shares, Red chips, and P chips, covering about 85% of this China equity universe.
Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in an index.
The original author of this piece has left the firm.