ETFs: ‘Saber rattling’ won’t deter investors from Chinese markets, expert says

VettaFi Vice Chair Tom Lydon joins Yahoo Finance Live to explain how the COVID situation in China has weighed on the ETF space and the overall state of Chinese markets.

Video transcript

JARED BLIKRE: We're joined by VettaFi Vice Chair Tom Lydon for this week's ETF report, brought to you by Invesco QQQ. Tom, great to see you here. Let's get the skinny on this. We've seen China kind of be its own animal, its own asset class this year, almost. It bottomed before. Lots of other asset classes did this year. And it's actually outperforming over the last few months. Just wondering how you see this setup for the new year.

TOM LYDON: Oh, you're right, Jared. It's been brutal for China. The COVID policy that they had, the zero-COVID policy, did not help their economy, didn't help the markets at all over there. Many markets in China were down over 80%. Specifically, KWEB, which is the one that most people talk about, hit a 80% down mark just a couple months ago. But since that point, in the last couple of months, it's been up over 70%.

So a lot of people are thinking there's a rebound. But not only that, you talk about generational opportunities. When you look at companies that have been spending a lot of time in China, you've got a lot of stocks that have P/E ratios in the single digits, something that we haven't seen in decades.

And, listen, China is not going to go away. There's been a lot of saber-rattling politically and also from a trade m but Xi is not going to disconnect from capital markets. And if you want to get some of that rebound, there's some great ETFs to consider.

SEANA SMITH: Yeah. Tom, I think the question here for investors at this point heading into the new year is how long it's going to take in order for that economic recovery to materialize, because we are seeing that case count, looks at least, going higher every single day in China, how much that's going to hold this economic recovery back. So if you are willing to take that risk and allocate some of your holdings to China, what should be the screening process, just in terms of when you're trying to identify some of the winners and the losers when it comes to ETFs?

TOM LYDON: Seana, it's a great point. And, listen, it doesn't mean that we can't hit lower lows from this point. China economy is in tough shape. However, I think the big word for 2023 is "diversification." We in the US tend to have a home-country bias. We've got way more allocated to US companies, and that's really worked well since we came out of the financial crisis.

However, if you look at volatility, you look at value, you look at the prices that you can get in stocks overseas these days, it's really quite incredible. And if you've got some staying power, you know, 5 to 10 years, what most of us have, it's worth diversifying into those areas. I think we look back a couple decades ago when China was the place to invest and a lot of people made a lot of money, we never thought we'd see those opportunities again, but here they are in front of us. So we know historically, when it doesn't feel good in your stomach, usually means there's opportunities ahead.

JARED BLIKRE: Well, Tom, wanted to get your thoughts on emerging markets in general, because if I go to an emerging markets ETF, like, EEM is one, that's going to be disproportionately representing China. Just wondering, would you say investing in a specifically Chinese ETF such as KWEB, the KraneShares internet ETF from China, is that better or worse than investing in something like a more general emerging markets product?

TOM LYDON: Just by the sheer amount of companies in the market capitalization in emerging markets, China is just going to dominate. So, yes, there are some great ETFs like EEM, because they're measured-- their index are measured on market capitalization, you're going to see more. However, if you want to get into some other ETFs that are more diversified, equal weight by countries, there's some opportunities there, too.

Or you can go to single countries. One of the best performing ETFs this year was the iShares Turkey ETF, up 93%, ticker TUR. So take a look at that. One other thing to consider, folks, is currency had a big play in the underperformance of emerging markets this year. The dollar was really strong. So it not only was affected by the price of the stocks within those countries, but when you had to convert them to the US dollar when the dollar was on fire, you paid for that as well.

We may see the reversal in the dollar when markets start to settle, especially when the Fed finally finishes fighting against inflation. So that's another thing to look out, because currencies today really are an asset class.

SEANA SMITH: And, Tom, when it comes to-- there certainly has been an investor appetite here for ETFs, and you can see that by the fund flows. They're expected to exceed $630 billion for the year, from the numbers that you sent over, the second best year on record. When we talk about what's accelerating this move into ETFs and what you think that's going to look like heading into 2023, are you expecting another year that's going to be this strong?

TOM LYDON: Well, it definitely is the investment vehicle of choice, and unfortunately for the mutual fund industry, the tax efficiencies of ETFs and the fact that you're not getting year-end capital gains distributions in a year where you think about, for the first time in 40 years-- where we've seen both bond market, mutual funds, stock market mutual funds, declining, many are kicking off big capital gains, because in order to raise money to meet these redemptions, they're having to sell low-cost-basis stock.

So it's kind of adding insult to injury. So you're seeing more money starting to shift over to ETFs that tend not to at all have capital gains distributions. That's something to think about. And, again, Seana, I would say this. If we ever see more ETF proliferation within 401(k) plans, it's really going to be doomsday for the mutual fund industry, because in most cases, that's where most of the new money is going, into mutual funds via 401(k) plans.

SEANA SMITH: Certainly something to keep an eye on. Tom Lydon, always great to have you. Thanks so much for joining us here this afternoon.