Reflation, Rotation, Hot Money, Cold Feet, Let’s Call the Whole Thing Off

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A lot of speculative capital, so-called hot money, has flowed into China lately. Last year, foreigners — lured by Beijing’s successful Covid-19 containment and swift economic recovery —  snatched up a record $408 billion worth of the country’s bonds and stocks. It was also a bet that U.S.-China geopolitical tensions would ease as Donald Trump’s second bid for the White House faltered. The yuan rose as much as 10% against the greenback as foreign portfolio managers advocated a “buy China” thesis.

All that hot money has got Beijing hot and bothered. Just a week ago, Guo Shuqing, China’s banking czar, warned of asset bubbles abroad and at home. And in the last couple of days, the National People’s Congress announced a  conservative economic agenda, which has tamped down the country’s frenetic bourses.

Now, the investing stratagem is getting a big shake-up. 

First and foremost, there’s the effect of rising U.S. bond yields. Last year, foreigners bought a record $187 billion of  Chinese bonds, mostly government issued. But the interest rate differential between U.S. and China debt that underpinned that inflow has been narrowing. The trend suggests more pain for those investments: U.S. bond yields are likely to rise further because they have  yet to reflect economists’ optimistic forecasts of 7.6% nominal growth in gross domestic product, a 32-year high. 

Reflation, Rotation, Hot Money, Cold Feet, Let’s Call the Whole Thing Off

Second, global stock markets are witnessing a dramatic rotation from growth to value stocks, with investors dumping high-flying names such as Tesla Inc. and Cathie Wood’s tech-heavy ARK Innovation ETF for shares in banks and energy companies.

Take a look at the composition of the benchmark S&P 500 Index. Growth sectors, such as technology, healthcare and consumer discretionary, make up for more than half of it, while value plays, such as financials and energy, account for only 12% and 3%. The current rotation — the so-called reflation trade — explains why the U.S. market has been so volatile lately. 

But Chinese stocks are hardly prettier. If the U.S. concentration in FAANG stocks is worrisome — their outsize representation increasing the pain of violent sell-offs — investors should really be concerned about the lopsidedness of the Chinese equivalent: Alibaba Group Holding Ltd., Tencent Holdings Ltd. and food delivery super-app Meituan.  The trio — nicknamed ATM — account for almost 35% of the MSCI China Index, which has tumbled as much as 16% from its mid-February high. 

Reflation, Rotation, Hot Money, Cold Feet, Let’s Call the Whole Thing Off

Last but not the least, Beijing’s ever-shifting economic priorities can quickly sink markets. Back in 2018, mainland Chinese stocks experienced a deep, depressing bear run, as Beijing’s draconian corporate deleveraging campaign, first launched in late 2017, led to debt-ridden, distressed companies all over China. Three years ago, local governments were desperate for money themselves and not paying their bills to private enterprises in time. As a result, businesses that were active in the so-called public-private partnerships, such as Beijing Orient Landscape & Environment Co., struggled

We are seeing a hint of that again. China Fortune Land Development Co., the country’s largest industrial park developer, has accrued 19.4 billion yuan ($2.92 billion) in overdue debt. As of September 2020, accounts receivable at the developer — essentially bills municipals need to pay —  ballooned by 41% from a year earlier to 55 billion yuan. That’s roughly the same size as its annual cost of goods sold. That is a lot. 

Buyers beware! As the NPC goes on, President Xi Jinping and his top lieutenants are again talking up bubbles and deleveraging. The sprawling bureaucracy apparatus is prone to going overboard to prove its fealty to his schemes and will likely implement the policies at a fanatical rate.

Reflation, Rotation, Hot Money, Cold Feet, Let’s Call the Whole Thing Off

To be sure, the tech bulls — in both the U.S. and China — have not yet capitulated to the reflation trade. Despite heavy selloffs, ARK’s Cathie Wood sees a broader bull market and has kept her eye on the prize. In the past, when interest rates were on the rise, American households moved their wealth from cash to stocks, according to Goldman Sachs Group Inc. This makes sense, especially if rising bond yields signal economic strength. What’s a better way to express conviction in your country’s economy than to buy stocks? 

But even if growth stocks manage to stay in fashion, the calculus has changed. Last year, because China was the only major economy growing amid the pandemic, global investors had no choice but to invest in mainland stocks and bonds, despite the nation’s patchy governance record. But now that the U.S. is back on the path to recovery, they don’t have to stomach Beijing’s shifting policies any longer. As any emerging market knows, hot money can get cold feet — and flee. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

©2021 Bloomberg L.P.

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