French fund house Amundi would overweight China stocks if they were to fall another 5%-10%, and there are three events that could spark such a drop in the coming six months, argues Anthony Ho, chief investment officer for Asia ex-Japan equities.

He was referring to a potential British exit from the European Union (on which the referendum is taking place today), a US rate hike and the US presidential election.

Amundi is currently neutral on China stocks. “We are expecting more volatility in the coming months,” Ho told AsianInvestor. “The equity market right now is more range-bound, not yet directional. This year is more tactical in terms of opportunity.”

However, Amundi research dating back to 1998 shows that when Asia ex-Japan stock prices fall 10% – or one standard deviation – from the current level, that is a strong buy signal, regardless of market fundamentals.

And if Chinese stocks decline another 5%-10%, they will have fallen one standard deviation below the current level, Ho said.

What’s more, he noted, Chinese equities are among the cheapest in Asia by price-to-earnings (P/E) ratio. The forecast P/E for China over the next 12 months is 10.3x, the lowest in Asia ex-Japan apart from Korea (10.1x).

China’s five-year average P/E is the joint lowest (9.6x) with Korea, as compared to Australia (13.6x), Hong Kong (14.9x), India (15x), Indonesia (13.7x), the Philippines (15.7x), Malaysia (14.7x), Singapore (13.4x), Taiwan (13.3x) and Thailand (11.3x).

More volatility imminent

If Britain were to vote to exit Europe, sharp volatility would hit the global market, not just Europe, Ho said. People will become more “risk-off”, and shift money into deposits or buy more bonds.

In that case, he noted, more liquid markets, such as Hong Kong, would typically suffer, with money being pulled from cross-border investments into China, thus impacting Hong Kong and mainland equities.

Companies with close export links to European markets would also be immediately affected, Ho said. Moreover, European companies on the mainland would delay expansion in Asia, which would directly impact China from a foreign direct investment perspective.

However, the ensuing panic would mark a good time for smart investors to accumulate positions in China equities, he said.

On the other hand, if the UK votes to remain, that would mean the US Federal Open Market Committee to can revert to assessing rate rises under more normal circumstances and would hike twice this year, said Ho. That in turn would trigger another global equity market sell-off, he added. 

And then there is the US presidential election, scheduled for November 8. A win for Hillary Clinton's Democrats would mean a continuation of Barack Obama’s foreign policy, which would be the more stable outcome for Asia.

However, if Donald Trump were to come out on top, he would likely adopt a more aggressively protectionist approach against countries such as China. Such an outcome would trigger a fall mainland stocks.

So which sectors would Ho be interested in if the 10% drop were to occur?

For one thing, Amundi would stay away from some of the more risky areas, such as banks. Ho said non-performing loans at Chinese banks were likely to rise over the next 12 months. That is why banks have seen fairly cheap valuations of late and are likely to stay cheap for some time, he noted.

'New economy' stocks stocks such as healthcare and technology would be preferable, he added.