Despite China’s strong economic recovery and solid stock market returns, foreign investors are reluctant to increase their exposure to the world’s second-largest economy amid rising geopolitical tensions and uncertainties.
According to Reuters, decades-long foreign bullishness on China’s capital markets is breaking down, as investment flows and interviews with fund managers suggest a new era of caution fuelled by political risks and U.S. investors especially wary.
Data from EPFR shows that allocation to U.S.-domiciled China funds hit a record low last October and has been falling on an annual basis for four years. Flows figures show net foreign buying of about 188 billion yuan ($27 billion) this year, but most of that was crowded into January when hedge funds were riding momentum as COVID rules relaxed and markets rallied.
The investment mood reflects political discomfort in the West with China’s rise, as well as fears of sanctions, regulatory crackdowns, and human rights issues. Some investors are also concerned about China’s abrupt reversal of its zero-COVID policy, which could lead to a surge in infections and deaths.
Hayden Briscoe, Asia-Pacific head of multi-asset portfolio management at UBS Asset Management in Hong Kong, told Reuters that foreign money at the moment, particularly from the U.S., is reluctant to invest. He said many managers are steering clear after seeing wartime sanctions erase the value of Russian investments.
“It’s around capital preservation, not really the returns,” he said. “Foreign money at the moment, particularly from the U.S., is reluctant to invest.”
He added that some investors are still looking at geopolitical risk and the Russia experience recently probably makes them more tentative than they normally are.
The lack of long-term anchoring investors also makes the market more volatile, driven by the ins-and-outs of “quick money”, according to Bank of America’s chief China equity analyst Winnie Wu.
The consensus among economists that the U.S. economy will slip into recession this year is unusually and remarkably strong, which points to a poor outlook for earnings and equity performance. However, some investors say this is the perfect set-up for a contrarian bullish investment strategy.
In the near term, however, China COVID fears may overshadow the long-term benefits and weigh on sentiment accordingly. China’s Caixin manufacturing purchasing managers index for December is expected to remain in recessionary territory for a fifth straight month, falling to 48.8 from 49.4 in November.
This follows official PMI data at the weekend that showed the sharpest pace of contraction in December in nearly three years as COVID-19 infections swept through production lines after Beijing’s sudden policy shift.
China’s economy is going through an incredible amount of economic, political and social upheaval, which will be intensified in the coming weeks and months by Beijing’s new approach to the pandemic. UK-based health data firm Airfinity estimates that around 9,000 people in China are probably dying each day from COVID, and expects COVID cases to reach their first peak on Jan. 13 with 3.7 million daily infections.
China firing on something approaching all cylinders would offer a much-needed boost to the world economy this year. The impact on asset markets, however, is less obvious as potential inflationary pressures from the economic reopening could force central banks to keep interest rates higher for longer.