The market implications of a U-shaped Chinese growth recovery
In the Emerging Market Macro Daily of Nov 1, Li Cui and MK Tang discuss China’s cyclical turn
and note the decline in trend growth but better recent macro data, which has largely improved
from the July/August trough. This has helped Chinese equities enjoy a (rare) period of
outperformance. We expect a modest acceleration of Chinese economic activity, but feel that
expectations of a significant move towards a more proactive stimulus around the leadership
change may be overdone.
For Chinese equity markets, we would argue that the recent run of outperformance was primarily
a reduction of hard landing risk (and some increase in growth expectations), which leads us to
believe that Chinese equities may trade sideways for some time. When policy settings for the new
leadership become more clear – and we feel they are likely to be gradual as opposed to dramatic
– in the first half of 2013, we feel a more sustained rally will be possible, but that we may endure
a number of “false positive” episodes until then, where periods of excitement are tempered by
long waits, or qualifying statements.
Localized China effect, not yet a catalyst for cyclical EM
The inaugural Emerging Market Macro Daily (October 30) discusses the outlook for EM generally
and the heterogeneity of EM performance, but the China factor, through both direct and indirect
effects, is probably the most important long-run factor for EM equity. That said, the dispersion
across China-related assets (Exhibit 23) since the recent low in China, suggests that the China
‘factor’ has been largely limited to Chinese equity markets, rather than a widespread global
phenomenon which would probably require a stronger policy stimulus.
Liquidity begets liquidity
In this report, we turn our analysis to the area of (equity) liquidity across growth markets (Where
is it? How consistent is it? What is it sensitive to? How large are relative trading costs? Are
liquidity and performance related?). Since some of GM and much of EM do not enjoy the same
level of liquidity as the developed markets, many fund managers need to be wary of the ebb and
flow of liquidity. In addition, they should be aware of the cost of that liquidity (which has an effect
on expected returns). We aim to assess, analyze, and compare liquidity statistics across the
growth markets.
Assessing market impact, roughly
Ultimately, what investors concerned about is not really what level of liquidity is available: they
concerned about how much the price will move as they trade in or out of a stock, and are using
liquidity as a heuristic to estimate that function. We believe we can improve that heuristic by using
two additional dimensions: trade-weighted bid/offer spreads, and average trade size. That said,
the topic of market impact is a highly complicated one, and our goal here is to present a rough
comparison across GM, rather than a definitive market impact model. Finally, we compare returns
of high vs. low liquidity stocks over the past 5 years and find that low liquidity has largely
outperformed since Jan 2010. However, for a trade size of $50 mn, we believe that trading costs
would have offset much of the low liquidity outperformance, on average.