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Is china cracking?

After stunning recent returns, advisers are starting to turn away from China to other markets, says Helen Pow

Many industry figures have tipped European equities to be this year’s top-performing market while others are looking further afield in search of outperformance but what are the areas where investors should be steering clear?

Many people tipped Japan as a top performer last year but it turned out to be the worst-performing equity market although with signs that some problems are behind it, it may not be such a poor choice this year.

BestInvest head of communications Justin Modray is optimistic about Japan’s prospects and despite the yen hitting a low last week, the equity markets seem to have a positive outlook.

It seems the country to avoid this year is China. It had a remarkable 2006, with the MSCI China index returning 82.87 per cent but many believe the market is overvalued and are now much more cautious.

Aberdeen Edinburgh Dragon fund manager Jeremy Whitley says: “Few new listings have met our quality criteria yet some have reached astronomical valuations since coming to market.”

Whitley warns investors not to “gorge impulsively” on shares in local-listed companies because, sooner or later, weaker fundamentals will expose themselves and investors will realise that these companies’ earnings are not growing as strongly as the Chinese economy.

He says: “We remain conservative on China. The valuations of mainland-listed companies are looking increasingly stretched, suggesting the stockmarket is due for a pause.”

IFA Blackadders director Keith Thomson says: “Chinese companies are not as profitable as they were. Many are reducing their margins to remain competitive.”

Schroders executive director and head of equity markets Virginie Maisonneuve says Schroder’s will reduce its exposure to both Russia and Spain this year.

She says: “We feel uncomfortable with Russia and some parts of Eastern Europe. We would much prefer to play Eastern Europe through Western European companies involved in the area. We will also be careful with Spain because of the overheating of property.” Modray says: “If there is a slowdown, emerging markets could be the worst hit and could react badly. I would not want to invest more than 10 per cent.”

There is disagreement over which equity markets are going to underperform. Small to mid-cap companies have outperformed large caps in recent years but this may not last. Last year, the FTSE All Small Companies index grew by 20.4 per cent and the FTSE 250 finished the year up by 30.21 per cent. By comparison, the FTSE 100 grew by 14.43 per cent but many fund managers are suggesting that it is the turn of mega caps, the top 15 FTSE 100 companies, to shine.

Thomson says: “Mega caps are regarded to do very well this year. A lot of fund managers have already moved from small or mid caps to the mega caps.”

But Modray says: “Many managers said big companies would outperform smaller companies last year but we did not see that. I think we are likely to see an even spread across the board.”

Maisonneuve says there is a lot of liquidity in the market which could mean that big and mega caps excel.

She says: “I would not put small caps in the doghouse for the long term but in the next 12 months there is a very decent chance for large caps to catch up. There is so much liquidity that there are lots of people around who can afford to buy those companies.”

At the smallest end of the market, Thomson says investors should be wary of some Aim stocks, particularly VCTs.

He says: “Investors need to make careful stock selections. People are going in blindly for tax reasons rather than investment reasons.”

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