SINGAPORE (Dec 7): Global investors should give attention to China as it offers compelling opportunities.

The country is showing signs of an inflection point in managing its growth deceleration and credit expansion, according to State Street Global Advisors (SSGA), the asset management arm of State Street Corporation, in its annual Global Market Outlook.

Kevin Anderson, head of investments, Asia Pacific for SSGA, says, “We think markets are overstating debt fears and underestimating China’s growth prospects, which may provide a window in 2018 for investors to gain long-term strategic exposure.”

However, SSGA cautions there is a need for investors to be selective.

It identifies the country's consumer spending as the biggest long-term trend and notes that many large Chinese banks are attractively prices due to their ability to grow earnings, protect balance sheets and pay dividends.

Compared to A-shares, Anderson prefers overseas-listed shares and more specifically offshore Chinese equities, because MSCI China has much higher exposure to high-growth and quality IT and consumer companies, while H-shares listed in Hong Kong have a lower valuation than their A-share counterparts.

Fixed income investors also cannot ignore the fact that China is now the third largest bond market in the world.

“Chinese government bonds offer higher yields at similar ratings to major sovereigns. With the arrival of the Bond Connect link, it will not be long before Chinese onshore bonds are included in major bond indices used by global investors. In our view, these bonds, which currently have a low foreign investor participation rate, offer yield enhancement compared to other major developed sovereigns,” says Anderson.

Globally, SSGA forecasts a more evenly distributed growth, which is expected to return to its historical trend rate of 3.7% in 2018, supporting company earnings and pushing equity markets higher.

Within the US, SSGA sees the best opportunities further down the cap spectrum, while viewing developed markets such as Japan and Europe as particularly attractive.

According to Rick Lacaille, global chief investment officer for SSGA, global growth is slowly but steadily improving. And paired with modest inflation, provides a macro environment that can continue to lift markets higher.

“Valuations, although extended in some sectors, remain below fair value at current interest rate levels. Japan is arguably the most attractive developed market, given relatively low interest rates and a weak currency,” says Lacaille.

Meanwhile, active managers are seeing a challenge in historically low interest rates and policy-driven liquidity following the global financial crisis through higher correlations and lower volatility.

Lori Heinel, deputy global CIO for SSGA, says, “That backdrop is changing. However, careful consideration of where, when and how to go active is essential in order to strike the right balance alongside smart beta and core index exposures.”

On the other hand, SSGA also sees more opportunity in bond markets.

“While we are unlikely to see the bond bull to keep charging in 2018, we do think the bears will probably be proven wrong for another year, even as the Fed is expected to raise rates and other major central banks begin tapering their accommodative policy,” says Lacaille.

Hence, investors are advised to balance duration and credit risks carefully, as emerging market debt valuations may have become less attractive, but a tilt towards quality can continue delivering results.

Although volatility currently remains low, the SKEW Index continues to be elevated, which suggests that investors are worried about a low-probability, high-impact market correction.

“We are at that point in the cycle when investors should review the tail risk protection in their portfolios. The fundamental backdrop remains favourable, however. We think investors should look both ways. They should take a more cautious and risk-aware stance as they step forward to make the most of the opportunities that synchronised global growth will likely offer in 2018,” concludes Heinel.