China A-Shares Strategy │ Recent market update
- China equity markets have been modestly weaker in the past couple of weeks, tracking the US – and the pullback in technology stocks, in particular.
- The composition of the China A-shares market is very different with a much more diverse and less technology-oriented structure. The largest company in the MSCI China A Onshore Index is a white liquor stock – with a 4.6% weighting.1
- Nonetheless, the rotation out of previous top performers is also very evident – sectors such as technology and healthcare have seen significant profit-taking and laggard sectors such as utilities have rallied.
- These market movements are taking place against the backdrop of familiar macro risks. President Trump continues to put China at the centre of his re-election battle. Earlier last week he reiterated his commitment to a “decoupling” of the world’s two largest and most closely integrated economies.
- However, while the end of “Chimerica” continues to be a topic for debate, on the ground there are still relatively few signs of action. This week the results of a PwC China survey of more than 200 American companies with operations in China found that fewer than 4% of respondents were relocating production capacity back to the US, and more than 70% had no plans to relocate any manufacturing out of China, despite the higher tariffs.
- In terms of capital flows, US investors are estimated to have around USD 1 trillion of exposure to China stocks. Of this, around half is in US-listed ADRs. Only USD 100 billion is in China A-shares, the majority from hedge funds and mutual funds.2 It would, in theory, take around 130 days for US investors to fully liquidate their ADR holdings, but just three days for A-shares. Any direct decoupling impact on A-share markets is therefore likely to be limited.
- The reluctance of American companies to leave China may have been bolstered by the latest signs that the Chinese economy has largely bounced back from the pandemic. Very few domestic Covid-19 cases have been reported in China over the past month.
- Furthermore, with a tried and tested pandemic playbook in place to handle any renewed outbreaks, the strict public-health controls of earlier months have largely been dropped. Temperature and health checks are still a common occurrence, but most people in China are no longer wearing face masks, and nightlife is returning to cities.
- With restrictions relaxed, the services sector is beginning to rebound. Leisure activities are picking up – restaurants are re-opening and food orders are up 12% from January.3 Box office sales have ticked up as well, and domestic trips for business and entertainment are also bouncing back. The volume of domestic flights in China is close to the same level as a year ago – in fact 13 carriers reported operating more flights than in August last year.
- The “first-in, first-out” economic thesis for China has also been reinforced by the Q2 results season. Aggregate net profits for China’s almost 4,000 listed non-financial firms were flat y/y, compared to a 50% decline in Q1, and operating cashflows rebounded sharply.4 With the economic recovery becoming more broad-based, the improvement in listed earnings is likely to continue for the remainder of the year.
- We believe these improving fundamentals could also help support China’s equity markets. It has been reassuring to see this pullback happen in a relatively controlled manner, and without the sort of sharp day-to-day swings seen in previous years. We stick to our view that this is a “speed bump” and a period of healthy consolidation after the sharp rally.
Unless otherwise stated, all details are sourced from Allianz Global Investors as of 11 Sep 2020.
1 Source: MSCI, as of 31 Aug 2020.
2 Source: Goldman Sachs, as of 7 Sep 2020.
3 Source: Gavekal, as of 7 Sep 2020.
4 Source: Gavekal, as of 1 Sep 2020.
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