Market volatility spiked as US President Donald Trump started delivering on a campaign promise to rework “bad” trade deals struck by his predecessors. First, he announced tariffs on Chinese steel and aluminum. Then, he announced plans for a 25% tariff on $60 billion of mainly high-tech products from China1 relating to intellectual property rights.
As expected, China retaliated by threatening to add an additional 25% levy on about $50 billion of US imports including soybeans, automobiles, chemicals and aircraft.2 Most recently, it was reported that Trump is considering an additional $100 billion in tariffs on selected Chinese goods.3
Much ado about nothing?
Through their recent actions, we see the US and China both attempting to stake out strong positions before heading to the negotiating table. For China, the immediate impact is expected to be small — we estimate these tariffs will apply to only about 2.7% of the country’s total global exports. The initial damage to the Chinese economy could be a minor reduction in gross domestic product (GDP) of between 0.1% and 0.2%.4However, the medium-term impact will likely be mitigated by export diversification. With China’s GDP predicted to grow at 6% to 6.5%5 for the next few years, the impact of these tariffs is expected to be barely perceptible even if fully implemented.
That said, the headlines and risk of a trade war certainly contributed to volatility and weakened investor appetite of late, especially considering the market’s strong performance in 2017.
Conditions in China
Despite the market volatility in the first quarter, Asian companies overall (ex Japan) saw strong positive revenue and earnings revisions. These were driven primarily by upward guidance by companies in China — rising over 11% in the past six months.6
Interestingly, the revisions during the last quarter were more positive for momentum and growth stocks than for quality and value stocks. Quality stocks often initially underperform in economic upturns because stable earnings usually lag behind cyclical stocks with rapidly accelerating earnings.
At the end of the first quarter, China’s price-to-earnings ratio (P/E) for the next 12 months was approximately 12.5x,6 which the Invesco International and Global Growth team considers attractive and is well below the benchmark’s ratio of 17x.6
Conditions in Japan
The Japanese yen has strengthened 5.7% this year, while the Nikkei 225 Index has remained flat in local currency terms5 as “Abenomics” continues to struggle to deliver on its target of 2% inflation. Please note that a strengthening currency is generally bad for export-driven economies like Japan.
Earnings revisions for Japan were some of the strongest globally, linked to a host of reasons such as improvements in capacity utilization as a result of weak capacity growth, industrial output, as well as yen distortions. However, from our perspective, fundamentally little has changed. Japan’s current governance levels are ranked amongst the lowest in the world (according to Thomson Reuters Datastream ESG data), while company return on equity metrics are still about 400 basis points below global averages.6
That said, valuations are starting to look more compelling, with an average P/E ratio of 13x versus the global average of 17x.6
Our EQV approach
The Invesco International and Global Growth team seeks companies with attractive Earnings, Quality and Valuation (EQV) traits. With the possibility of further volatility, we believe our approach may benefit investors for the following reasons:
- High-quality companies have the ability to adapt to the environment even if geopolitical concerns erupt.
- We believe quality companies tend to fair better during volatility.
- Quality and valuation may become more important to investors, should volatility remain high.
We were able to add several new companies in China during the first-quarter selloff, including Henan Shuanghui Investment & Development Co. Ltd. (China’s largest processed pork producer) and Wuliangye Yibin Co. (a Chinese spirits manufacturer) (0.73% and 0.90% of Invesco Asia Pacific Growth Fund; 0.73% and 0.90% of Invesco Developing Markets Fund, respectively, as of March 31, 2018). Both are in the consumer staples space and both have very strong brands and high market share. These two companies were also holdings of Invesco International Growth Fund as of that date, at 0.76% and 0.60% of assets, respectively.
We also added Sunny Optical Technology Group Co., a new high-quality tech name for both Invesco Asia Pacific Growth Fund and Invesco Developing Markets Fund (0.70% and 0.70% of the funds, respectively, as of March 31, 2018). This company was not a holding of Invesco International Growth Fund as of that date.
In Japan, while there are still relatively few high-quality companies trading at attractive valuations, the increased volatility gave us the opportunity to add a new consumer staple name, Asahi Group Holdings, during the quarter (0.72% of Invesco International Growth Fund as of March 31, 2018). This company was not a holding of Invesco Asia Pacific Growth Fund nor Invesco Developing Markets Fund as of that date.
Looking forward, we welcome further volatility as it could increase the possibility of adding new companies at attractive valuations.
- Source: BBC.com, “Trump announces tariffs on $60bn in Chinese imports,” March 2, 2018.
- Source: CNN.com, “China fires back, announcing tariffs on US planes, cars and soybeans,” Daniel Shane, April 4, 2018
- Source: CNN.com, “Trump threatens China with new $100 billion tariff plan,” Jackie Wattles and Jethro Mullen, April 5, 2018
- Source: J.P. Morgan, data as of March 31, 2018
- Source: Bloomberg L.P., data as of March 31, 2018
- Source: Invesco, data as of March 31, 2018
The price-to-earnings ratio measures a stock’s valuation by dividing its share price by its earnings per share.
The Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the first section of the Tokyo Stock Exchange.
Abenomics refers to the economic policies advocated by Shinz? Abe since the December 2012 general election which elected Abe to his second term as Prime Minister of Japan. Abenomics is based upon “three arrows” of monetary easing, fiscal stimulus and structural reforms.
Holdings are subject to change and are not buy/sell recommendations.
Diversification does not guarantee a profit or eliminate the risk of loss.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
The funds are subject to certain other risks. Please see the prospectus for more information regarding the risks associated with an investment in the fund.
Investments in companies located or operating in Greater China are subject to the following risks: nationalization, expropriation, or confiscation of property, difficulty in obtaining and/or enforcing judgments, alteration or discontinuation of economic reforms, military conflicts, and China’s dependency on the economies of other Asian countries, many of which are developing countries.
The iShares FTSE/Xinhua China 25 Index ETF (FXI) fell $0.26 (-0.55%) in premarket trading Friday. Year-to-date, FXI has gained 1.97%, versus a 0.76% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of Invesco.