China’s equities and its currency have more room to rally in the near-term as multiple securities are about to be added to global indexes or to have their weighting increase, presumably leading to capital inflows that could deliver a boost to the local market, an Oxford Economics strategist said.
“Last week’s market nervousness raises the question as to whether the sharp rebound in Chinese equities and the yuan is overdone. We do not think so,” said Gaurav Saroliya, director of macro strategy at the research firm.
“Like with most global risk assets, the recent pace of gains was unlikely to be sustained and a pause was healthy," but Saroliya said the momentary retreat is unlikely to derail what he perceives as a bullish, near -term momentum for China assets.
Last week Friday, China’s Shanghai Composite Index SHCOMP, +0.80% dropped 4.4%, its worst session since October. The Shenzhen Composite 399106, +1.02% fell 3.8% and CSI 300 Index 000300, +1.03% declined by 4%, on the same day.
But so far in 2019, the three indexes have significantly outperformed the S&P 500 SPX, -0.09% Year to date, the Shanghai Composite has soared 21.4%, the Shenzhen Composite is up 30.7%, and the CSI is up 23.7%. The S&P, in comparison, has only gained 12.4%, according to FactSet data.
One reason to remain bullish on Chinese assets is the recent developments in terms of index inclusions. The MSCI Emerging Market index 891800, -0.19% is set to increase the weight of Chinese A-shares this year, which will drive up capital flows and support both local stocks and the yuan USDCNY, +0.0312%
“For 2019, this boost implies inflows equal to nearly $70 billion,” said Saroliya.
So far, that dynamic has helped to positively correlate the yuan’s move with gains in China’s equity market as demand for both currencies and equity increase. The following chart highlights the emerging positive correlation between stocks and the yuan, meaning the assets have tended to move in the same direction at the same time.
Moreover, Chinese government bonds will be included in the Bloomberg Barclays Global Aggregate Index starting April, implying further inflows of some $175 billion over a period of 20 months, Saroliya added. “Hence, we think both the yuan and a-shares have much further to go, justifying a buy-the-dip stance on both.”
Since mid-October last year, the MSCI China Index MCHI, -0.62% has outperformed the MSCI All Country World Index 664204, -0.04% That said, the China index underperformed in months leading up to October, thanks to strong U.S. equities following last year’s tax cuts and worries about trade tensions.
“But trade tensions have been easing,” said Saroliya. “We do not think the impact of trade peace is fully in the price just yet.”
“Sceptics could point to the continued decline in industrial profits and correlates such as PPI inflation. But we have shown how these quantities lag credit creation which is pick up now. We do not think the Chinese growth recovery will halt in its tracks for wants of further policy action. Hence, China outperformance on this count should continue.”
Tariff negotiations to resolve the yearlong Sino-American trade dispute hasn’t yielded a pact in recent days. However, progress on trade between the two largest economic superpowers has provided some stability to global markets.