Janus Henderson: Could 2019 see a much needed shake-out?

What are the key themes likely to shape markets in 2019?

Macroeconomic factors have largely driven Chinese equity markets this year and – given the huge significance of these global events – we would expect them to shape markets in 2019.

Firstly, the beginning of quantitative tightening* and rising interest rates in the US has triggered a shortage of US dollars in emerging markets and precipitated much weaker emerging market currencies. In China, we see a more powerful government than in many other emerging markets. With trade surpluses falling, we can expect more currency volatility than previously. Secondly, we will be watching closely to see how rising US/China trade friction develops and how China reacts. In 2019, we will start to see the impact of the trade war on global supply chains. International relations are already evolving rapidly: at the start of 2018 we would not have predicted an official visit to Beijing from Japanese Prime Minister Abe.

Where do you see the most important opportunities and risks within your asset class?

Importantly for us as stock pickers, shares in many of the sectors considered to have more growth characteristics - such as internet, healthcare and consumer - have come back to buyable ‘growth at a reasonable price’ levels. Consequently, both growth and value areas of the market now offer opportunities. Unfortunately, this is the result of sentiment turning more negative during the year but the medium-term outlook is positive; driven by urbanisation, rising incomes and social change.

Despite increased foreign investor interest in Shanghai and Shenzhen listed ‘A’ shares following their inclusion in MSCI indices**, 2018 has been a poor year for these markets. As we write, domestic sentiment is poor and risk aversion so high that market implied discount rates (the return demanded by investors to compensate them for investing in the market) are very high. This can often be a good time to add exposure as long-term investors, despite how uncomfortable that feels.

We do not currently own any Chinese bank shares because, with reforms and regulatory pressure on the sector, they are likely to be a value trap. We are also avoiding companies with US dollar debt, i.e. Chinese property development companies. Perhaps 2019 will finally see many of these companies’ funding channels dry up and a much needed consolidation phase take place. This would be troublesome for bank shares, reinforcing our view on that sector.

How have your experiences in 2018 shifted your approach or outlook for 2019?

There is no shift in our investment approach, which has been proven over many years. Rather we just accumulate another year’s experience and some more wisdom to inform our judgement going forward. We are reminded how fickle and extreme investor sentiment can be in China: Chinese ‘H’ shares started January 2018 with 17 consecutive ‘up’ days. Investors in China need patience, persistence, tenacity and stamina!

*Quantitative tightening is the opposite of Quantitative Easing where the central bank employs a contractionary monetary policy to decrease amount of liquidity within the economy.

**An MSCI index is an international measurement of stock market performance in a particular area. MSCI stands for Morgan Stanley Capital International.