Late last week and early this week, HK/China markets sold off along with other Emerging Markets (EM), triggered by accelerated devaluation of EM currencies, excluding the Chinese Renminbi (CNY).  Macquarie Equities Research (MER) published a report on 28 Jan 14 on this topic and the following are excerpts from the report.
 
MER expects worries of further QE tapering and a China slowdown may linger in the near term and facilitate further capital rotation out of EM risk assets. If so, cyclical sectors may come under the most pressure in the next month. However, on a 6 to 12 month period, MER reiterate their positive views on China equities. Read on to find out why.

Main triggers – accelerated devaluation of EM currencies fuelled fears globally. Following an 11% drop in the Argentinean peso last Thursday, currencies in Brazil, India, Indonesia, Turkey, South Africa and Russia plunged. Global equity markets rolled over with VIX spiking to a 3-month high last Friday, reflecting investors’ fears of global contagion. While HK/China equities have also been pressured by soured risk sentiments, MER highlights that China is different from most other EMs
1) resilient currency-CNY is among very few EM currencies that has strengthened against USD over the past year,
2) limited external debts and abundant foreign currency reserves – one of the key concerns over some EMs is the rapid decline in reserves may potentially lead to insufficient support to the value of their currencies.

The real risk, in MER’s view, comes from the self-fulfilling mechanism of currency crisis, which may exacerbate the existing reserve problems of some EMs.
 
Underlying drivers – capital flight from EMs and slowing growth in China. The materialisation of the Fed’s cuts in asset purchases from January and the uncertain pace of tapering has again triggered capital flight from EM and facilitated EM currency devaluation. In addition, recent macro data provided not-so-bright prospects for EM risk assets – a weakening China and strengthening Europe and US. In the very short term, factors that could stabilise investor sentiment include,

1) inaction (and dovish rhetoric) at the January 28-29 FOMC meeting,
2) relatively better official and/or HSBC China PMI readings for January (vs. HSBC flash PMI at 49.8).

Over a 3 to 6 month period, MER believes China is a relatively safe place to be among EMs as the top leaders’ reform efforts may start to improve the macroeconomic outlook in 2^nd half of 2014.
 
What if it is a repeat of May-Jun last year? – Cyclical sectors under most pressure. The prevailing EM weakness in recent past weeks has likely reminded investors of the EM sell-off last May. MER expects EM risky assets and capital allocation to China to be affected in the near future due to uncertainty on further QE tapering.

MER highlighted that in the month after Bernanke first indicated potential QE tapering (22 May 2013), the worst performers in the MSCI China space were Materials, Banks, Real Estate, Metals & Mining, Diversified Finance, Energy and Industrials, while the most resilient sectors include Info Tech, Health Care, Staples, Telecoms and Automobiles. While most recent sell-off featured profit locked-in previously outperforming sectors (e.g. Health Care, Info Tech) and capital flight from financials (due to concern of credit risks), MER believes imminent downside risk is highest for cyclical sectors if market confidence on EMs further deteriorates.

Source: Macquarie Research - 30 Jan 2014