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Why China Could Surprise Markets to the Upside

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Chinese growth concerns were a key trigger for the sharp fall in markets in August and September last year, and we believe were one factor that dissuaded the US Federal Reserve from hiking interest rates in September 2015. Those concerns returned again at the start of this year, when financial markets sold off sharply for a second time in the space of a few months. Surveys of investors regularly show a China hard landing as high on the list of worries. But with the first signs of China’s substantial policy stimulus now showing in the economic data, the country may yet surprise markets to the upside this year.

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Market Realist – Stabilizing economy could boost markets

China is experiencing severe pains while its economy is rebalancing in favor of consumption-led growth. Given the emergence of China (FXI) as a major economic force, the slowing growth inflicted heavy damage on the global (VT) (VXUS) economy in 2015. The Fed had to keep interest rates unchanged in March due to risks surrounding China’s economy. Similarly, excessive global financial market volatility in 2015 and at the beginning of 2016 was mainly emanated from the economic malaise in China. Weaker growth, currency volatility, and consistent capital outflows caused tremendous anxiety among global investors.

Is a surprise in store?

However, the massive financial stimulus package unleashed in China (MCHI) appears to be supporting economic growth in 2016 and 2017. Recent economic data like strong infrastructure investment, the rebound in the composite purchasing managers’ index, and a recovery in exports suggest that the economy is on the verge of stabilization.

The resilient economic growth that’s expected to persist in 2016 will likely translate into higher growth for Chinese equities. After a sharp sell-off in 2H15, Chinese stocks recently got their mojo back. Now, they’re moving higher. The benchmark Shanghai Composite Index rallied around 10% after falling to its one-year low in February.

Despite the recent run, Chinese (GXC) stocks are currently trading at a forward price-to-earnings multiple of 13.3x—compared to its five-year high of 20.2x in June 2015. The lower valuation combined with stimulus measures will likely result in Chinese stocks surprising on the upside in the next few quarters.

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