A Tale of Two Sentiments: Uninvestable and Unstoppable
First, a Video and a Podcast
The future path of the labor market is critical for Fed policy, and thus markets through the rest of 2021. To dive deeper into this topic, we released a video last week looking at trends in the labor market, consumer spending, and implications that this data has on markets.
Last Friday we released a new episode of our podcast, Fieldpoints of View. Thanks to our guest, Andy Rothman, an investment strategist at Matthews Asia, the episode contains helpful insight into how investors can think about Chinese markets and geopolitical issues.
If this podcast piqued your interest and you would like to dive deeper into these topics about China’s economy and markets, we’ve included a collection of helpful articles and podcasts at the end of this piece.
A Tale of Two Sentiments: Uninvestable and Unstoppable
At first glance, it is striking just how different investor and commentator sentiment is towards the U.S. and China.
After the recent regulatory crackdowns (see the Further Reading section below if you would like an overview of what has happened), China has been called “uninvestable,” with reports of well-known funds significantly reducing their China exposure.
According to data by Copley Fund Research and featured in this FT article, global funds have slashed their China exposure to only ~3.75% from well over 5% at the end of 2020 (see Chart 1). This small exposure is notable when you consider that China was over 18% of world GDP in 2020.
Chart 1: Global equity funds reducing China exposure
Now contrast this to the U.S.
The American Association for Institutional Investors released its August Asset Allocation update recently, showing equity allocations are near the 2018 pre-correction high and getting near highs not seen since the tech bubble (see Chart 2). Cash balances are near similar extremes, but at lows (see Chart 3). Bond allocations have declined in 2021, but are not at lows (Chart 4).
Further, U.S. households’ exposure to equities as a percentage of their financial assets is at a record 36.5%, higher than even the 32.5% reached in 2000 (Chart 5).
Based on these metrics, there doesn’t seem to be a whiff of worry in U.S. equity markets.
We have also see U.S. tech stocks shake off fears of regulation much more resolutely than in China.
Last week a “massive blow” was dealt to a large consumer tech company in a court ruling, only to have analysts quickly note that a shortfall in this business would quickly be made up by substantial growth in other areas. The stock was down on the day but by a mere ~4%.
Reflecting this impervious sentiment, there was a Barron’s article from a few weeks ago calling big tech “unstoppable”. That should make anyone who is aware of the curse of the cover (that Barron’s cover proclamations are typically contrarian indicators) at least a little nervous.
Of course, being unflinchingly bullish in the face of U.S. regulatory threats has been the “right trade” and served U.S. tech investors very well over the past decade.
A Trillion Reasons Why
Comparing sentiment in U.S. vs. Chinese markets seems to be an effort in the obvious, but let’s still articulate the broad sources of differences.
The U.S. has a fairly stable regulator environment (at least with a bark worse than its bite); has stimulated aggressively since the pandemic (trillions of USD, including backstopping debt markets); and has a market dominated by companies with a strong ability to grow earnings at a rate many multiples of GDP growth (even during an economic lockdown).
Conversely, China has had an anything but the stable regulatory environment in recent months; has been much lighter on its stimulus (including allowing overstretched borrowers to risk failure and allowing the bond market to shudder), and has the future earnings potential of some of its largest constituents being challenged by these harsher regulations.
These contrasting traits between the two markets help to explain the U.S. outperformance over China YTD (Figure 1).
This analysis is not about calling a turn in China’s markets (we’ll leave that to the local experts, or at least some screaming technical signals), but instead about holding a mirror up to our own markets.
The sharp downdraft in former China tech-darling shares reveals two sensitives: 1) how high valuations, such as in tech, are quickly deflated if there are real risks to business models, and thus stellar earnings growth, through regulation, 2) how retail investors can turn on a dime and flee for the exits when spooked.
The first sensitivity is assumed by many to be a long shot in the U.S. for now. This is because harsher regulations are difficult to move through the U.S. political process, and even when and if they do, they have barely dented the profitability of the total businesses. It is unlikely that the U.S. follows in the swift footsteps of China’s one-party regulatory roll-out, and is even unclear if they will imitate Europe in its relatively more stringent regulations. But we should not write off any regulatory risks in the U.S. completely.
The second point is an important one given the rising role of retail traders in the U.S. Retail traders are ~30% of the U.S. equity market, which is up substantially vs. pre-pandemic, but is far smaller than the 60-70% that is retail in China (see the Casino Capitalism podcast below).
When asked what could make the S&P 500 not bounce off of its 50-day moving average and thus have a correction greater than 5%, our frequent answer has been “spook the wall of retail money into not buying the next dip” (which is a non-answer answer without a catalyst).
Let’s see this time around. As of this writing, we are sitting right at that 50-day moving average.
One last thought to tie all of this together is to remember just how important large U.S. consumer/tech companies have been to returns in 2021.
Despite being only 2% off of its all-time high, over half of the S&P 500’s constituents have already experienced drawdowns of more than 10%. This indicates a small cohort holding the broader index aloft. This can also be seen by a falling number of stocks trading above their longer-term trend line 200-day moving averages (only 73% vs. 97% in April).
None of this is to say that the end is nigh for dominant U.S. tech. The earnings train continues to chug along sans-regulation, and as this Bloomberg article points out, U.S. tech has shown a powerful ability to quickly grow into its elevated multiples, justifying soaring stock prices.
The message is to be aware of these market sensitives that are revealed by the Chinese experience over the last few months. And probably to take any maximalist classification (“unstoppable”, “uninvestable”, etc.) with a big ol’ grain of salt.
Further China Reading and Listening
These are complicated and fast-moving topics. To continue to try to get a better understanding of these topics, here is a collection of some helpful articles, podcasts, etc. about China and its recent market activity:
What are China’s markets: China has multiple different indices, each with every different exposure. This is a quick summary of these different markets.
Navigating China’s “Casino Capitalism”: a Bloomberg podcast detailing how a quantitative investor trades China’s markets, where valuations are often divorced from fundamental
Sup China’s China Tech Crackdown Timeline: This is a collection of articles from around the financial press brought together by Sup China.
Sup China’s Guide to China’s Big Tech Crackdown: This is a well-organized article about the different areas where the Chinese government has focused its regulatory crackdown.
The FT’s Robert Armstrong on if China is Uninvestable: This opinion piece gathers together a collection of other helpful articles and perspectives on China, as well as displays some interesting data on China fund flows (spoiler: there have been big outflows out of China).
The FT looks at both sides of the China investability debate: this article provides examples on both sides of the debate regarding whether or not the recent moves should deter investors from having exposure to China.
An Economist podcast on China’s goals in the tech crackdown: a quick discussion about what China’s ultimate goals could be in pursuing these tech crackdowns.
Adam Tooze’s historical perspective on U.S.-China Relations: It’s good to zoom out and gain historical perspective, and Adam Tooze is particularly well suited to offer this. A key point here is that he disagrees with the wildly popular Graham Alison thesis of China and the U.S. being locked in a Thucydides Trap (“destined for war”). If you prefer a podcast, this is a discussion with Adam Tooze on Sinica.
Chapter 11 “Casino Capitalism” of Quinn & Turner’s Boom and Bust: This is a great, short history of China’s capital markets and their penchant for volatility (the rest of the book is a very worthwhile read as well).
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