For qualified investors

New opportunities in Chinese equities

11-Jun-2018
By Richard Turnill

Key points

  1. The gradual inclusion of China A-shares in MSCI indexes creates new opportunities in Chinese equities, supporting our preference for EM Asia.
  2. Last week’s market tone was risk-on. Global stocks rallied, led by the US Brazil’s real plummeted and then rebounded, while the euro rose.
  3. US-North Korean leader talks this week may result in agreement on denuclearisation principles – and a process for further negotiations.

New opportunities in Chinese equities

China’s equity market – the world’s second largest by market capitalisation – is opening up to global investors. We view the initial addition of onshore Chinese shares (“A-shares”) to MSCI indexes as a key first step in opening access to the full range of Chinese equities. It gives investors exposure to what we see as some compelling domestic sectors and supports our preference for EM Asia including China.

Chart of the week

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.

Increased access to the China A-share market may offer diversification benefits to global investors. The chart above shows how A-shares (orange line) have historically had a much lower correlation with global equities than broader emerging market (EM) stocks (blue line) and Chinese shares listed offshore in Hong Kong (H-shares – green line). This means A-shares haven’t moved as closely with global equities during the ups – and downs. One reason: Until recently, A-shares have been isolated from foreign capital by restrictions on foreign ownership and have been heavily influenced by the higher-frequency trading of local retail investors. Other factors include different sector exposures and ownership structures. We see the inclusion providing equity investors with more complete exposure to the Chinese economy as well as greater access to some of the attractive growth stories in China.

A primer on MSCI’s A-share inclusion

MSCI incorporated 226 large-cap A-shares into its indexes on June 1, the first step in a process toward including 5% of eligible A-shares by September. Foreigners previously invested in China mainly via H-shares and US-listed Chinese companies. They held just 2% of A-shares amid government quotas and investor concerns about corporate governance and volatility. China’s weight in the MSCI EM Index will rise to roughly 31% from 30% after the initial inclusion. It would be nearly half if A-shares are eventually fully included.

A-shares’ correlation with global equities may rise as foreigners increase exposure, but we expect this to take years, not months. For now, we see A-shares offering diversification benefits and fuller exposure to China’s old and new economies. A-shares have higher exposure than H-shares to Chinese industrials and materials, whose earnings outlooks continue to benefit from supply-side reforms. Further, we believe the market is underappreciating the global competitiveness of A-share listed Chinese manufacturers. The market-cap weight of the tech sector is higher in H-shares, but A-shares have a broader range of tech sector exposure and a larger weighting to other “new economy” sectors such as health care and consumer staples. Their share of “new economy” stocks is growing as China evolves to a consumption-driven growth model. Finally, A-share valuations appear fair, in line with long-term averages.

There are risks. Chinese equity volatility has been twice that of global equities since 2006, and A-shares staged a spectacular boom-bust in 2015. Market regulators have since implemented reforms, and MSCI inclusion focuses on select A-shares. Other risks include US-China trade tensions, a rapidly appreciating US dollar and China’s corporate governance issues and financial vulnerabilities. Yet economic activity in the world’s second-largest economy is proving resilient, as we expected, and China’s near-term economic outlook is solid. A-shares’ greater domestic exposure can potentially help cushion equity investors against trade risks. We see China’s financial leverage as a longer-term risk. Bottom line: A-shares’ index inclusion supports our view that there is opportunity in EM Asia.

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  • Risk-on sentiment sent global equities rallying, led by US stocks. European equities lagged their counterparts. The VIX fell to levels last seen in January. The Nasdaq hit a new high. US 10-year yields neared 3% before retreating.
  • European bonds sold off. Markets perceived European Central Bank officials’ remarks as signalling a taper of net asset purchases by year end. The euro rose versus the dollar (USD). Italy’s new prime minister confirmed the government aims to implement a range of populist policies. Eurozone investor confidence fell to the lowest level since October 2016.
  • The Brazilian real plummeted to a two-year low versus the USD before rallying on news of central bank intervention. The lira recovered after Turkey’s central bank raised its policy rate more than expected. The rupee advanced after a surprise rate hike by India’s central bank. The IMF said it reached an agreement to offer Argentina a $50 billion loan.

 


 

  Date: Event
June 12 Trump-Kim meeting; US Consumer Price Index (CPI): OPEC Monthly Oil Market Report
June 13 FOMC meeting statement; eurozone industrial production; IEA Oil Market Report
June 14 European Central Bank meeting statement; China industrial production, retail sales, fixed asset investment
June 15 Bank of Japan meeting statement; Planned US release of list of Chinese goods subject to tariffs; US industrial production

A Singapore summit between US President Donald Trump and North Korean leader Kim-Jong Un is likely to result in both sides agreeing to a set of principles on denuclearisation and a process for further negotiations. This could include additional summits and other confidence-building steps.  Any process will be lengthy and risks being derailed by issues surrounding implementation, interpretations of the principles and verification. Our BlackRock geopolitical risk dashboard shows price reaction to North Korea news has been muted recently as market attention has shifted elsewhere. Tensions – and market attention – could increase quickly if talks fail.

Richard Turnill
Managing Director, ist Global Chief Investment Strategist von BlackRock
Richard Turnill ist Global Chief Investment Strategist von BlackRock. Davor war er Chief Investment Strategist von BlackRocks Fixed Income und active Equities ...

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