Got the U.S. Earnings Jitters? China Has a Haven for You

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(Bloomberg Gadfly) -- Just as U.S. markets are looking increasingly toppy, China offers a great haven.

The S&P 500's dip Thursday is a fine reminder U.S. equities are entering the danger zone. Expectations are sky high, with sell-side analysts predicting earnings growth of almost 30 percent. Anything from a miss by cigarette maker Philip Morris International Inc. to a weak outlook from Apple Inc. supplier Taiwan Semiconductor Manufacturing Co. can sink the market.

Investors are nervous.

Global allocation to stocks is at an 18-month low of 29 percent, down from 41 percent in March, according to an April survey from Bank of America Merrill Lynch that canvassed funds with about $650 billion in assets. Only 5 percent of portfolio managers expect the economy to be stronger in the coming 12 months, the poorest sentiment since June 2016's Brexit vote.

There are so many clouds on the horizon. U.S. President Donald Trump's protectionist bent has the ability to bring corporate growth to a shuddering halt. Treasury yields are ticking up and the curve keeps on flattening, a possible omen of recession.

One may argue that CFOs of American firms are efficient financial engineers. U.S. companies have been avid buyers of their own stock, giving back almost $1 trillion of cash to shareholders, including dividends, last year. Goldman Sachs Group Inc. says U.S. equities can return 5 percent in 2018 as firms shell out an impressive 43 percent of earnings to investors.

But with the S&P 500 rising faster than corporate profits, the benchmark's cash yield is falling, touching 3.2 percent in the first quarter, down from 4.3 percent a year ago.

Let's shift the focus to China, whose stocks will enter MSCI Inc. indexes in June.

This week, the People's Bank of China surprised the market with a reserve ratio cut. This isn't helicopter money; the move was estimated to have injected only 400 billion yuan ($64 billion) of liquidity, much smaller than last October's action.

Still, it's a nice gesture. A day earlier, Beijing reported slowing nominal GDP, which, according to Bloomberg economists Tom Orlik and Fielding Chen, is a warning the industrial reflation cycle that drove corporate profits higher is fading. A reserve cut signals to the world that China isn't abandoning global growth at a time Trump's policies may be killing jobs.

The response from overseas investors was telling. Foreigners snapped up 7.2 billion yuan of mainland shares through the two stock connects in Hong Kong, the most since October. Basically, they're looking for any excuse to make the geographical shift into the world's second-biggest economy.

What's more, international investors aren't after cyclical stocks, rather those with direct exposure to China's rising middle class. Money flowed into Kweichow Moutai Co., the world's most profitable liquor maker, Jiangsu Hengrui Medicine Co., a contender to become China's Johnson & Johnson, and tech-savvy Ping An Insurance Group Co.

China wants these offshore billions to help build the nation's Nasdaq. Securities regulators last month removed profitability requirements for tech and biotech startups.

From May, China will quadruple the daily northbound trading quotas for the Shenzhen and Shanghai pipes, a move that may eventually raise mainland shares' weight in the MSCI Emerging Markets Index to 15 percent, according to Bloomberg Intelligence analyst Sharnie Wong. More than $1.6 trillion of assets track the gauge, so a full inclusion would bring some $240 billion of inflows into China.

It's only a matter of time before Beijing starts to lobby MSCI again. Global fund managers, circumspect regarding an elevated S&P 500, should be watching China with keen interest.

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

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

©2018 Bloomberg L.P.

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