China’s equities to hit tipping point in 2019

“Investors are unlikely to be surprised that China offers the most attractive earnings growth prospects of all five markets highlighted,” the Nomura analysts, led by Jim McCafferty said.

“China’s economy is the least developed in this universe and is growing at the fastest pace. We think it is more interesting to consider China relative to its developed peers on two other fundamental metrics which may appear more suitable for more mature developed markets.

“First, the forecasts show that MSCI China’s average dividend growth for 2019 and 2020 is 10.2 per cent. This is the highest of its global developed market peers.

“Second, the level of indebtedness at MSCI China is much lower than international peers. This suggests to us that China is a much less risky market than its MSCI classification might suggest.”

There are big index changes looming this year which will drive increased flows of money into China by global investors. China’s classification as an emerging market has tended to suppress international flows in the past.

Barriers to investing

The other negative factors that have proved a barrier to foreign investment in Chinese equities include trading suspensions of China A shares, lack of alignment of Chinese share settlement periods, lack of access to hedging and derivative vehicles, lack of local currency liquidity, trading holidays, lack of access to initial public offering, no properly functioning stock lending for short sellers, lack of stability in stock indices and lack of efficiency in best execution.

This helps explain why foreign investment in China ranks among the lowest of about a dozen markets in the region. For example, the proportion of foreign investment in the Australian market is about 35 per cent compared to 10 per cent for the markets in China and Hong Kong and only 2.5 per cent for the markets in Shanghai and Shenzhen.

The constraints on accessibility listed above were identified by index provider MSCI in a document prepared as part of its consultation over the inclusion in its indices of a larger proportion of Chinese shares.

MSCI and FTSE announced in September plans to increase the numbers of China A shares in their global indices. This was not a shock but the magnitude of the changes were greater than expected.

MSCI said it would increase the weight of China A shares in the MSCI global indices from 5 per cent to 20 per cent by the end of 2019 and FTSE said it would lift the weighting of China A shares to 5.6 per cent of the FTSE Emerging Market index after March 2020 and lift the “all-China” weight to 37 per cent of Emerging Market world based on the latest prices.

Goldman Sachs said in a note to clients at the time that the MSCI changes “could usher in $US$41 billion to $US59 billion of net buying for the 235 existing China A-share constituents for the two tranches of inclusion in May and August this year.

It said the FTSE changes could cause $US8 billion in incremental flows.

S&P Dow Jones said last week it would include more China A shares in its indices this year in recognition “the evolution of its markets over the last several years, including increased market accessibility to foreign investors through the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect programs”.

China has the leading stock market capitalisation in the region but the lowest level of foreign ownership. Index weighting changes could turn the tide. 

“Therefore, S&P DJI will add eligible China A-Shares that are accessible via the Shanghai-Hong Kong Stock Northbound Connect or Shenzhen-Hong Kong Stock Northbound Connect facilities to S&P DJI’s Global Benchmark Indices with an emerging market classification effective prior to the market open on September 23, 2019 using a reduced weight factor of 25 per cent of each company’s investable weight factor.

Nomura said another factor that could drive Chinese stock prices higher this year was the likelihood the central bank would start buying shares.

“We think that the Chinese authorities are likely to consider using the PBOC as a new lever of power in the stock market this year,” Nomura said.


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