After Shrugging Off Shenzhen-HK Connect, Chinese Stocks May Be Headed Higher


The approval of the Shenzhen–Hong Kong (SZ-HK) Connect by China’s State Council came with a muted market response, which could overshadow what is likely a more favorable outlook for Chinese equities, the economy and investor risk appetite.

Similar to the Shanghai-Hong Kong Connect that allows foreign and Chinese investors to trade on and offshore Chinese equities, the commencement of the SZ-HK adds an additional 880 stocks to the 567 already available.

A larger concentration of Shenzhen equities is new economy, including technology and healthcare stocks, compared to Shanghai listings which predominately consist of state owned enterprises and banks.

In aggregate, the main boards of the Shanghai and Shenzhen indices total US$7.4 trillion, second to the S&P’s US$19.7 trillion index and above Tokyo’s exchange of US$5 trillion.

The SZ-HK Connect acts as a turning point in sentiment, as the second mainland link with Hong Kong follows a disappointing MSCI outcome this summer when the index compiler denied China’s A-shares into its benchmark indices.

MSCI’s decision echoed many investor concerns, particularly those regarding repatriation limits, which would squeeze fund managers faced with redemptions. The early year correction in China’s equity market that led to circuit breakers and trading suspension remains fresh on investor minds.

While the cautious approach partially explains the market response, investors do appear more comfortable with the RMB. The SZ-HK announcement came a year after the People’s Bank of China (PBOC) surprised markets and devalued the currency, which has since depreciated 4% against the U.S. dollar, following a one day drop of almost 2%.

Coupled with better communication from the People’s Bank of China, economic data also portends well for currency stabilization. Foreign exchange reserves have hovered around US$3.2 trillion for most of the year, as the precipitous drop last year was triggered by local accounts looking to settle overseas debt.

China’s deflationary environment is also improving. July’s producer price index contracted 1.7%, better the previous month’s 2.6% drop due to a month on month increase in metal prices.

Easing deflation continues to reflect that more than a modicum of excess production has been removed; alleviating the real burden of debt and reducing the need for the central bank to cut interest rates that would further instigate the RMB.

China’s reform remains on track, and investors should continue to expect ongoing evidence of further market liberalization and RMB internationalization. But supporting Chinese equities is also a lackluster backdrop of low global rates, which now includes nearly US$13 trillion of negative yielding bonds.

When the RMB joins the IMF’s Special Drawing Rights (SDR) in the beginning of October, it should be noted that China’s RMB will be the only SDR currency that supports positive nominal and real bond yields.

The aforementioned remains supportive for Chinese equities over the medium and longer term. Besides the official inclusion of the RMB into the SDR, the MSCI is expected to review the A-share inclusion later this year, as the SZ-HK connect addresses one of the group’s concerns over repatriated capital.

Improving market and economic outlook should feed into elevated risk appetite for the asset class. The initial market response suggests some reservations remain, which only makes us more sanguine.

The article is written by Christopher Chu, fund manager Asian equities at Union Bancaire Privée (UBP) and edited by China Money Network editors

China Expert Network
 
China Expert network

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