December 11, 2017

China offers compelling opportunities for global investors in 2018 as it shows signs of an inflection point in managing its growth deceleration and credit expansion, says State Street Global Advisors, the asset management arm of State Street Corporation (NYSE: STT), in its annual Global Market Outlook released last week.

The coming year could well be a break-out year for China and time to take advantage of market mispricings, says Kevin Anderson, head of investments, Asia Pacific for State Street Global Advisors. “We think markets are overstating debt fears and underestimating China’s growth prospects, which may provide a window in 2018 for investors to gain long-term strategic exposure.”

However, State Street Global Advisors says investors need to be selective. It identifies consumer spending as the biggest long-term trend and notes that many of the large Chinese banks are attractively priced relative to their ability to grow earnings, protect balance sheets and pay dividends.

Anderson favours overseas-listed shares over A-shares. “We prefer offshore Chinese equities for two reasons: MSCI China has much higher exposure to high-growth and quality IT and consumer companies, and H-shares listed in Hong Kong have a lower valuation than their A-share counterparts,” he says.

He also pointed out that fixed income investors can’t ignore China either now that it is the third largest bond market in the world. “Chinese government bonds offer higher yields at similar ratings to major sovereigns. With the arrival of the Bond Connect link, it will not be long before Chinese onshore bonds are included in major bond indices used by global investors. In our view, these bonds, which currently have a low foreign investor participation rate, offer yield enhancement compared to other major developed sovereigns,” Anderson adds.

Beyond China, State Street Global Advisors forecasts more evenly distributed global growth, which it expects to return to its historical trend rate of 3.7 percent in 2018, supporting company earnings and pushing equity markets even higher. The firm sees the best opportunities further down the cap spectrum within the US, and views developed markets such as Japan and Europe as particularly attractive.

“The slow but steady improvement in global growth, coupled with modest inflation, provides the kind of macro environment that can continue to lift markets higher,” said Rick Lacaille, global chief investment officer for State Street Global Advisors. “Valuations, although extended in some sectors, remain below fair value at current interest rate levels. Japan is arguably the most attractive developed market, given relatively low interest rates and a weak currency.”

The firm also expects that the ongoing move away from extraordinary monetary policy accommodation, alongside evidence of lower cross-asset class correlations, could be more conducive for active equity managers.

“Historically low interest rates and policy-driven liquidity following the global financial crisis have challenged active managers through higher correlations and lower volatility,” said Lori Heinel, deputy global CIO for State Street Global Advisors. “That backdrop is changing. However, careful consideration of where, when and how to go active is essential in order to strike the right balance alongside smart beta and core index exposures.”

State Street Global Advisors also sees more opportunity in bond markets. While further rate rises from the US Federal Reserve (Fed) and European Central Bank (ECB) are in store despite low inflation, the firm expects rates to stay anchored at a relatively low level.

“While we are unlikely to see the bond bull to keep charging in 2018, we do think the bears will probably be proven wrong for another year, even as the Fed is expected to raise rates and other major central banks begin tapering their accommodative policy. That said, investors need to balance duration and credit risks carefully. While emerging market debt valuations have become less attractive, a tilt towards quality can continue to deliver results,” added Lacaille.

State Street Global Advisors tempers its outlook with a degree of caution recognizing that, eight years into the growth cycle, some investors are increasingly wary of the potential for a pullback.

“While volatility remains low, the SKEW Index continues to be elevated, suggesting investors are worried about a low probability, high-impact market correction. We are at that point in the cycle when investors should review the tail risk protection in their portfolios. The fundamental backdrop remains favorable, however. We think investors should look both ways. They should take a more cautious and risk-aware stance as they step forward to make the most of the opportunities that synchronized global growth will likely offer in 2018,” Heinel concluded.