Renewed signs of activity in China have increased the risk that a “reflation” of the world’s second-biggest economy could catch out managers positioned for a deflationary shock.
China’s economic slowdown has been exerting deflationary pressure on the global economy for several years, but recent months have suggested the country is stoking credit growth in a bid to deal with the problem.
While this has prompted fresh worries over the potential popping of the country’s credit bubble, some managers have warned that the opposite outcome – that China is successful in reflating its economy – is not being factored in as a potential risk.
James Clunie, manager of the Jupiter Absolute Return fund, has profited in recent months from a short renminbi position designed to protect against a slump in China. The manager retains this position but said he was considering other scenarios.
“It is a ‘what if’ scenario, but what if China reflates? That will be a bit different,” he said.
“I have started talking to a few clients about this and they all say, ‘no one is speaking about this’. If it happens, everyone’s going to have to change their positioning.”
Mr Clunie pointed to signs that long-promised Chinese infrastructure projects such as its ‘One Belt, One Road’ trade route across Asia are now starting to roll out as evidence to support the theory.
Mark Richards, global strategist in JPMAM’s Multi-Asset Solutions team, said China was “reverting to its old habits” such as infrastructure spending and property investment.
“There’s a definite change in policy from being concerned about reform and corruption to one clear concern about the slowdown.”
Roger Webb, manager of the Aberdeen Strategic Bond fund, agreed perceptions were skewed in one direction.
“We have now got a world where 99 per cent of us tend to prepare for deflation rather than reflation,” he said.
Initial figures showing the extent of China’s new lending spree have already caught out economists. In March, for example, new credit in the country totalled 2.3trn yuan (£250bn), 30 per cent higher than the average economist surveyed by Bloomberg had predicted.
For fund managers and asset allocators, any pick-up in inflation would likely lead to riskier assets regaining popularity.
Ayesha Akbar, a portfolio manager at Fidelity Solutions, noted signs of life in China’s economy had already affected commodities. “If inflation were to go up materially, we prefer more risky assets like commodities and equities. Globally we are neutral on commodities,” she said.
Others believe that a sudden surge in global prices, if it were to materialise, would be temporary.
Hermes emerging markets manager Gary Greenberg said investors could afford to ignore a reflationary period, which he says could last “a quarter or two”.
“The word ‘brief’ is key,” he said. “If people can look through it, then they will ignore it.”
Ms Akbar said: “We are monitoring the inflation side. I understand it but don’t know if it’s sustainable... it could catch people off guard.”
