China breaks step with global markets, and investors buy in

Investor thinking on Chinese assets is changing, as steady returns through the turbulence of the Iran war and AI frenzy show how China has broken step with global markets, carving it a niche as a sandbag against volatility.

The shift has brought money into the bond market and encouraged investors to seek out stocks with drivers distinct from global trends.

“The role of China in portfolios is evolving from a simple emerging-market growth allocation toward a more nuanced source of diversification,” said Christopher Hamilton, head of client investment solutions for Asia Pacific ex-Japan at Invesco, a manager of about $2.2 trillion in global assets.

“Diversification is ultimately about combining exposures that respond differently to economic and market conditions, and China is increasingly being assessed through that lens.”

Since the Middle East conflict began at the end of February, China’s bond market has been the world’s strongest, and the yuan is the only major currency to have climbed against the dollar.

The currency’s gains helped mainland blue-chip stocks log an almost 11 per cent first-half rise in dollar terms.

While that lagged the roughly 13pc rise in the S&P 500 and the record 110pc surge in dollar terms for South Korea’s KOSPI, it came without the same reliance on the AI fervour or sensitivity to US rates driving other markets.

“It means that when we allocate to, and assess, Chinese assets, it is no longer determined by short-term valuations, trading sentiment or changes in the Federal Reserve’s interest rates,” said Liu Gongrun, executive deputy director at the CEIBS Lujiazui International Institute of Finance, a Shanghai-based think tank.

Detached from traditional drivers

China’s relative insulation from global market forces reflects an economy out of sync with the inflationary cycles in the rest of the world and a stock market dominated by retail investors with very different agendas to global fund managers.

Regulators, state banks and state-backed investors have also swung behind promoting stability as a policy goal, analysts say, something that’s supported the standout gains for the yuan.

The local currency’s 5.4pc advance against the dollar over the past 12 months has come in spite of broad dollar strength and rock-bottom yields, and is reflective of strong exports as well as authorities’ encouragement of a slow, steady rise.

The yuan is seen going further, with global banks revising up year-end forecasts for gains beyond June’s three-and-a-half-year high of 6.7522 per dollar.

“Yuan strength is sort of detached from traditional bog-standard long-run drivers like how the economy is doing,” said Kelvin Lam, senior economist at Pantheon Macroeconomics.

“Instead, it is policy driven the intention from the authorities to project currency stability at a time of global chaos.”

Foreign investor comeback

Keying on the same theme, global asset managers have turned buyers of stocks and bonds in a sea change for a market some had called “uninvestable” only a few years ago.

“There has been renewed demand for China bonds, which we believe was driven by relative safety and low volatility,” said Wee Khoon Chong, Asia-Pacific macro strategist at BNY.

China’s benchmark 10-year sovereign yields which fall when prices rise are down almost 10 basis points to 1.73pc since the start of the Iran war, against a 51 basis-point rise for 10-year US yields.

The bond market logged net foreign inflows for the first time in more than a year in May, the latest month for which data is available.

Foreign holdings of onshore A-shares also increased from 3.67tr yuan ($541bn) at the end of last year to more than 4tr yuan, Liu Haoling, vice chairman of the securities regulator, told a forum in late May. China has not published regular equity capital flows data since 2024.

To be sure, skeptics remain.

Manulife John Hancock Investments has been neutral to underweight China equities in some strategies because they lack the earnings growth of South Korea or Taiwan, said co-chief investment strategist Matthew Miskin.

Others are turned off by China’s moribund consumer and protracted property downturn.

“We aren’t thinking of it as a safe haven,” said Tom Graff, chief investment officer at Facet in Phoenix, Maryland.

“We certainly want to find assets that are less correlated to US markets, but in doing so we’re primarily thinking about risks around the AI trade and the US dollar,” he said. “Developed markets and some non-China emerging markets can serve that purpose just fine.”

However, many investors are drawn by the particular idiosyncrasies driving China’s divergence.

“We’ve long seen China’s market, especially onshore-listed China A-shares, as a rare source of diversification,” said Phillip Wool, head of portfolio management at Rayliant Investment Research.

“Now, in addition, you’ve got an actual economic decoupling that’s happening.” ...