Chinese stock markets, for all intents and purposes, just crashed. Over the last month, ETFs that track China’s stock markets have fallen between 15%-30%. Year-to-date losses sit around -10%, but that covers up the fact that the Chinese market was up more than 15% to start the year. This performance is weighing heavily on emerging market ETFs, like VWO, which have large allocations to China. If this was happening to the S&P 500 it would feel like March 2020 all over again. But I’m here to deliver some optimism, using lessons from the Covid crash as a guide.
“REITS will never come back”
Last year, when global markets fell in unison on the back of a Covid-induced economic lockdown, there was one sector that took it on the chin especially hard: commercial real estate. VNQ, the Vanguard Real Estate ETF, is a good proxy for the investable US commercial real estate market. VNQ invests in stocks issued by real estate investment trusts (REITs), companies that purchase office buildings, hotels, and other real property. It fell 34% from March 1, 2020-March 23, 2020 (the day markets bottomed), compared to a 24% decline for the S&P 500 over that same period.
There was a common conversation in the market back then, and that was how Covid and the ramifications of “work from home” had changed the commercial real estate market forever. The messaging at the time was it would be a long time before demand returned for office space, lodging, malls, or other real property that make up investments in ETFs like VNQ. Put simply, sentiment towards the sector turned very negative. Well guess what? The market had other ideas.
Since the March 2020 bottom, VNQ has rallied more than 85%. In 2021, VNQ is one of the best performing sector ETFs in the entire market, having risen 26%. That trumps the gains seen in any of the major indices so far this year.
With China and Emerging Markets, investors are at risk of making the exact same mistake that many made last year with Real Estate ETFs like VNQ. Current sentiment towards China and Emerging Markets is so negative, it’s next to impossible to see how anyone can make any money owning this space over the next 6-12 months. The belief in the market is that with China’s overbearing regulatory body cracking down on tech giants like Alibaba and Tencent (which would be like the US government cracking down on Apple & Google), the region will be dead money for the foreseeable future.
We caution against buying into, (or selling into, rather), this narrative. Just five months ago, China was home to the best performing stock markets in the world. If the future is as bad for Chinese stocks as everyone says it is, then that negativity has likely already been priced into their markets. And if it’s not as bad, like it proved not to be for the real estate sector last year, then China and Emerging Markets could very well be an outperforming group vs the US over the next 12-24 months.
Remember to avoid the grandiose of day-to-day headlines, whether they be domestic or abroad. We generally allocate between 5-10% of our equity sleeve to Emerging Markets. The definitive range is determined by client risk tolerance, not the ebbs and flows in the market. Right now, as China drives a sell-off in Emerging Market ETFs, we’ve been doing one of two things: buying, to bring allocations back into our target range, or holding through. Selling low in reaction to the recent jitters could be akin to betting that the commercial real estate sector would never recover from Covid. This too shall pass.
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