Pioneer on China: Opportunities in H shares
Pioneer’s head of Emerging markets, Mauro Ratto comments on recent equity market turmoil in China, analyses the measures taken by Chinese authorities, and forecasts for the next few months.
What’s happening to the Chinese Equity Markets?
A severe market dislocation across domestic Chinese exchanges has followed a period of broad domestic interest in equity investing. In recent weeks, many Chinese investors have opened A share trading accounts, in some cases receiving margin facility with their account opening. A margin facility allows investors to use shares as collateral i.e. lever up to buy more shares. The market’s strong performance in the second quarter increased the appeal of investing using margin financing, supported by a relatively benign stance from the Bank of China. A cooling in the market since June revealed an overleveraged retail investor, which in turn has led to a substantial de rating of Chinese risk. Exacerbating market concerns was a spike in inter-bank rates following increased IPO activity which tends to drain market liquidity.
What Are The Actions Taken By Chinese Authorities To Mitigate This Market Event?
The Chinese government has responded to the sell off with a number of policy steps, of which the most important is the Central Bank’s commitment to provide margin liquidity to the Chinese Securities Finance Co (CSFC), a state owned provider. The PBOC (People’s Bank of China) has stated that it has granted a further 250bn Renminbi of six month margin to the CSFC. The authorities have also asked 21 brokerage companies to invest at least 120bn Yuan into the market, in an effort to restore confidence and reduce selling pressure. They also appealed to stronger companies to buyback shares, thus diversifying the range of market participants active in the market.
Do you think that these measures will be successful?
These moves to restore confidence follow an earlier series of moves designed to stabilize capital markets and investor sentiment. The government announced a de-facto temporary suspension of IPOs in the domestic market to restore market liquidity. Earlier moves include benchmark rates and targeted RRR (Reserve Ratio Requirement) cuts, a proposal to allow the National Social Security Fund to invest in equities, a 30% reduction in transaction costs, amendments to mandatory margin call procedures, and a broadening of brokerage funding channels. Taken together, we believe these steps are fundamentally investor friendly. The move to diversify market participants in Shanghai and Shenzen, through the inclusion of a stronger institutional base, addresses a clear need in our view. While much attention has focused on equity performance, it is important to note that the bond markets have remained balanced. Chinese CDS (Credit Default Swsp) spreads have increased from a long term moving average of around 91- 104bps.
What Are, In Your View, The Implications Of Recent Market Corrections On Chinese Growth?
While grassroots participation in the equity market was increasing before 1 July, we estimate that Chinese savers deploy below 10% of their household savings in equities. Given that economic growth in China is now more balanced between investment and consumption, we expect this negative impact on wealth to weigh on growth. However, the impact should be contained and estimate it within a range of 50-80bps for 2015, bringing our 2015 GDP growth forecast to 6.5-7% . In our view, the quality of growth and its sustainability will remain key. Thus, we expect the government to remain focused on their reform agenda, particularly on increasing shareholder value in the state sector.
We acknowledge that recent choices have shaken investor confidence in policy credibility, and thus the governments’ management of the economy. Relative to regional peers, Chinese margin levels are not high: at the recent peak, the country deployed around 20% versus Taiwan’s 30%, for example. However, we believe complacency on margin lending rules and allowing a large proportion of its domestic listed companies to suspend trading without sound justification are likely to push back the inclusion of Chinese domestic stocks in the MSCI Emerging Markets index. A review by the IMF to consider including the Chinese Renminbi in the basket of Special Drawing Right (SDR) currencies, anticipated for year end, may also experience a set-back.
What’s Your View For Chinese Equity Market For The Next Few Months?
Despite this, we expect negative outcomes from the market’s recent turmoil to present manageable challenges for Chinese policymakers in the near term. In our view, the majority of the risk is now reflected in both domestic (A-shares) and Hong Kong listed (H-Shares) Chinese equities. We believe the opportunity now lies in the H-Shares market, where quality companies with strong potential for earnings growth trade at a substantial discount to the domestic A-Share market. We also expect a normalization in inter-bank rates over the next months, which should provide access to cheaper financing for companies. Further direct intervention from the government should also be expected. In May, the government announced a Renminbi 2 trillion debt swap, transforming short term loans into bonds with longer maturities to ease fiscal pressures. An operation such as this is akin to quantitative easing programmes pursued by developed market central banks. A similar “quantitative easing” policy for equity markets may be possible.
As a result, we remain positive across assets classes on the Chinese story. While Chinese markets have shown signs of pressure in recent sessions, we believe that the underlying quality of the Chinese investment story, well-resourced institutions and long term policymakers enjoy sufficient credibility to manage the subsequent outcomes.