Author: David Chao (Global Market Strategist, Asia Pacific)
MSCI announced this morning to raise the A-share inclusion factor from the current 5% to 20%, starting with Large Cap stocks and ChiNext Large Cap shares from its next index rebalancing in May. Instead of a two-step inclusion as proposed in its consultation, MSCI decided to conduct the weight increase in three steps to alleviate potential execution pressure on the implementation dates. Moreover, MSCI will add Mid Cap stocks, including eligible ChiNext shares, in its Nov 2019 index rebalancing, instead of May 2020 as earlier proposed.
Indeed, the China A-share market has been up 22% year-to-date, a sharp reversal of the underperformance last year against peers (-25%). The recent bull market rally in Chinese equities reflects a noticeable shift in international and domestic investor sentiment. This has also translated into a recent rally of the RMB, which is now the best performing major currency since the beginning of February.
There are a few reasons why we think investor sentiment has changed:
- Overly pessimistic last year: Chinese equities were hit hard last year as investors abandoned the asset class on concerns the economy was potentially falling off a cliff. Although the past 2 months have shown weak economic data, the world’s second largest economy continues to grow at a healthy 6.5% clip, with investors realizing their pessimism has been misplaced. We expect the recent foreign institutional fund flows into Chines equities to stick.
- US-China trade war amelioration: The 1st March deadline for additional US tariffs on Chinese goods has been delayed due to constructive trade dialogue between US and China; both the US and Chinese government have made positive comments about a potential deal being made between the two sides that covers not only trade disputes but also more complex issues such as forced technology transfers, Intellectual Property theft and Chinese market access.
- MSCI announcement: MSCI just announced an increase of the inclusion factor in large-cap A shares to 20% from 5%.
- Stock market reforms: This week’s comments in a Politburo meeting by China's President Xi Jinping that China would continue to deepen reform in the financial markets have caused Chinese financial stocks to rally in the past week; recent improvements in market accessibility have made it more convenient for foreign investors to invest in A-shares.
Outlook - long-term positive, expect near-term volatility
- Short-term volatility: While we have been bullish on the Chinese markets since the start of this year, we remain cautious on the decelerating Chinese economy and we think that there may be a couple more months of negative economic data and headlines – thus we expect volatility in the Chinese markets in the near-term.
- Supportive policies: Valuation right now remains reasonable. We think that the fiscal and monetary stimulus that the PBOC has undertaken recently will bear positive economic benefits in the second to third quarters of 2019.