The case for Chinese equities

MSCI A-shares inclusion update

Key themes

  • We are constructive on Chinese equities despite tensions over trade. We see protectionist threats as largely negotiating tactics, while Chinese reforms, a stable growth environment and a solid earnings outlook support equities.
  • MSCI’s A-Shares inclusion will begin in June 2018, kicking off a landmark event as the world’s second largest equity market is opened to foreigners.
  • Global ETP flows show investors are increasingly taking a single country view on China instead of accessing it through broad EM index exposure.

Still room to run

Last year, Chinese equities were among the world’s best performing assets. The MSCI China Index was up 54% in 2017, outpacing broader emerging markets, which were up 37%, and more than double the 22% return of the S&P 500 Index.1

Despite the strong rally in 2017, we remain constructive on Chinese equities amid a stable growth environment, ambitious reform agenda, and solid earnings outlook.

To be sure, the recent tensions over trade do represent a risk. However, we view U.S. trade actions targeting China more as an opening gambit for negotiations than the start of a trade war.

Moreover, China’s trade openness peaked over a decade ago as domestic growth drivers took on added importance, suggesting the economy may be relatively insulated from the effects of higher tariffs.2

We continue to see a strong reform agenda following the 19th National Party Congress supporting China’s pivot away from the “old economy” of credit-intensive, heavy industry and towards the “new economy” driven by technology, consumer spending, and healthcare.

The shift towards faster-growing, less credit-intensive sectors has the dual benefit of supporting aggregate growth while letting policymakers continue their financial deleveraging campaign without overly straining growth.

President Xi Jinping’s latest remarks on April 10th at the Boao Forum highlighted several reform efforts aimed at further opening China’s markets and which could help alleviate strained Sino-American relations.

In particular, President Xi outlined plans to further open China through:

  • Widening market access by raising foreign equity caps in the financial sector, easing restrictions on foreign financial institutions and reducing limits on foreign investment in manufacturing industries, including autos.
  • Improving the investment environment by aligning domestic policies with international economic and trading norms.
  • Expanding imports by lowering import tariffs on vehicles and holding the first China International Import Expo as a major policy initiative.
  • Strengthening intellectual property rights (IPR) by re-instituting the State Intellectual Property Office to enforce IPR and raise the cost of violating IPR to increase deterrence.