China and Emerging Markets

China is closed. The world’s second-largest economy is shut down due to the Coronavirus, and life is at a standstill. According to several news reports, the number of deaths from the virus has now surpassed the number of deaths from SARS – a frightening thought, and the uncertainty is making the situation worse.

China’s idleness will have, at some point, an impact on global economies and stock markets. The Chinese stock market is down .5% for the year, but this can change quickly.

Emerging markets and China are linked. Chinese stocks are 33% of the MSCI Emerging Market Index, so when China moves, so does the index. The index invests across five regions, 26 countries, and 1,100 securities.[1] Dimensional Funds, Fidelity, and Oppenheimer manage sizeable emerging market mutual funds, while Vanguard, Blackrock, and Schwab have substantial assets in their exchange-traded funds. The top holdings for most of these funds include Alibaba, Tencent, Taiwan Semiconductor, and PingAn Insurance Group.

The Matthews China Investor Fund (MCHFX) has produced an average annual return of 11.51% for the past twenty years, and it has a current asset allocation of 95% stocks, 5% cash. Most of their assets, 89%, are invested in Asian emerging markets.

Chinese stocks account for 3% of the global equity market capitalization, the same level as France and Canada.[2]  We recommend an allocation of 5% to emerging markets, so if Chinese stocks account for 33% of the index, our exposure to China is 1.65%. If Chinese stocks fall, the index will too. However, I’m willing to commit 1.65% of capital to the world’s second-largest economy.

During the AIDS epidemic from 1987 to 1995, the emerging markets index fell 6.7%, Chinese stocks dropped 40%, and the S&P 500 rose 34.9%.

Emerging markets rose 13.8% during the Bird Flu outbreak from 1997 to 2004. Chinese stocks plunged 65.6%, the S&P 500 rose 63.6%.

The emerging markets index rose 122% during the SARS epidemic from 2002 to 2005, while Chinese stocks climbed 74%, and the S&P 500 index grew 8.7%.

During the Swine Flu outbreak from 2009 to 2010, emerging markets soared 103.1%, Chinese stocks increased by 62.5%, and the S&P 500 was up 39.2%.

The Ebola outbreak occurred from 2013 to 2016. During this outbreak, emerging markets fell by 18.2%, Chinese stocks dropped 6.8%, and the S&P 500 rose 57%.

The United States stock market is massive, efficient, and developed, but it’s not immune to extended periods of poor performance. During the ‘70s, a 10,000 investment grew to $11,570, generating an average annual return of 1.47%. If you invested $10,000 in the S&P 500 on January 1, 2000, you had to wait thirteen years before you were profitable. But, if you held on to your original $10,000 investment from 1970, it’s now worth $357,820, producing an average annual return of 7.35%.[3]  For the past two decades, the S&P 500 and MSCI Emerging Markets Index produced similar returns.

Emerging markets have always been volatile – a feast or famine mentality. In 2006, Chinese stocks rose 82.9%. in 2008, they fell by 50.8%. Turkey rose 253% in 1999, and fell 45.8% in 2000, 32.8% in 2001, and 35.8% in 2002.[4] Volatility is the central theme for investors in emerging markets.

Does it make sense to sell all your emerging market holdings? My recommendation is to stay committed to this sector. Another reason to remain long emerging markets is demographics. China, India, Indonesia, Pakistan, Brazil, Russia, and Mexico account for 49% of the world’s population – and growing![5]

Rather than selling your emerging market stocks, invest in a globally diversified portfolio of low-cost funds, investing in an assortment of stocks and bonds based on your financial goals and time horizon.

What should you do if emerging markets fall? Buy more!

Nevertheless, I will bring health and healing to it; I will heal my people and will let them enjoy abundant peace and security. ~ Jeremiah 33:6 

February 10, 2020.

Bill Parrott, CFP®, CKA®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

 

 

[1] https://www.msci.com/emerging-markets

[2] Dimensional Fund Advisors 2019 Matrix Book

[3] YCharts.

[4] Dimensional Fund Advisors 2019 Matrix Book

[5] https://www.internetworldstats.com/stats8.htm