The event might have appeared trivial had it not provided additional evidence of the potential long-term appeal of Chinese equities, despite turbulence caused by the threat of a trade war between Washington and Beijing.
On June 1, China’s A-Shares – shares in major mainland Chinese companies, quoted in renminbi and listed in Shanghai or Shenzhen – became constituents of MSCI’s global and regional indexes. Previously, only Chinese stocks traded in Hong Kong or New York could be included in those indexes. The move, which Beijing had been seeking for years, concerns 234 companies, although their combined weighting in the MSCI Emerging Markets index is only 0.8 percent. On the surface, then, it is a drop in the ocean compared with the 3,500 companies that have A-Shares listed in China, with a combined market capitalization of around US$8.5 trillion.
Opening up the floodgates
In reality, however, their inclusion is a crucial milestone. Firstly, these indexes are tracked by institutional investors and passive investment instruments and so tens of billions of dollars will now automatically flow into the Chinese equity markets. That inflow will increase as Chinese stocks increase their weightings within the MSCI indexes. In addition, greater interest in Chinese stocks should encourage companies to bring their governance into line with international standards.
Even more significantly, the inclusion of A-Shares vindicates the reforms introduced by the authorities to open up China’s capital markets gradually to foreign investors. In the space of a few years, those markets have become much more accessible, due in particular to the internationalization of the renminbi and the loosening of restrictions on holding Chinese stocks.
“Stock Connect”, the system that has linked Hong Kong’s stock exchange with Shanghai’s since 2014 and with Shenzhen’s since 2016, has also played a role, as shown by the surge in cross-border volumes. The system allows foreign traders to buy and sell A- Shares as easily as stocks listed in Hong Kong.
The flotation of Chinese mobile phone giant Xiaomi on the Hong Kong market will also attract the attention of foreign investors. The company was considering a secondary listing in mainland China but seems to have postponed that plan, and analysts have lowered their valuation range. However, with a valuation of as much as US$70 billion, the IPO of this Chinese unicorn – whose smartphones have started to flood the international market –was one of the largest in recent years. After Xiaomi, other successful tech groups – with a combined market cap estimated at almost US$500 billion – will be queuing up to list on the Hong Kong stock exchange.
The fight against shadow banking
Chinese champions are also emerging in other strategic sectors. The “Made in China 2025″ plan, launched in 2015, is intended to boost the competitiveness of China’s manufacturers by helping them to move upmarket and become less dependent on foreign technologies. By 2020, at least 70 percent of their products must be made up of Chinese components.
President Xi Jinping has also made fighting pollution a political priority which, alongside the infrastructure sector, is attracting huge investment. Some “green economy” companies have already gained a significant edge, and the stockmarket authorities have said that they want to encourage responsible companies to access the capital markets.
Against the background of reforms intended to transition China “from high-speed growth to high-quality growth”, efforts to combat shadow banking – i.e. a method of financing the economy through risky loans from informal sources – are also starting to have an effect. Although China’s overall debt still looms large over the economy, its growth is slowing and the recent creation of a banking regulator with extended powers is a positive sign.
Domestic consumption takes over
Overall, Chinese growth remains robust. Although it has slowed from peaks of over 10 percent, the hard landing that is constantly seen as a threat by some has not materialized. Growth is expected to be 6.6 percent in 2018 after 6.9 percent in 2017, and the IMF expects it to remain around 5.5 percent until 2023. “In the baseline scenario, things are looking relatively good. Now it’s time to continue the tough reforms,” the IMF’s representative for China recently said.
Unless Donald Trump’s protectionist push complicates matters, indicators are largely positive for equities in the world’s second-largest economy, and recent declines can be regarded as a buying opportunity for the most solid stocks. Having previously been shunned by investors, Chinese equities have earned their place within long-term portfolios. This is especially the case given that, in the event of a trade war, Chinese companies are not necessarily the ones with most to lose.
Domestic consumer spending has been China’s main growth driver since 2011 and still shows scope for growth, which could make up for foreign uncertainties. In addition, even if the US closes the door to Chinese exports, they will continue to flow into other markets, particularly those in India and Southeast Asia, which remain buoyant.
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