Over-Weight of Chinese Shares Affirmed by Healthy Growth Forecast and Stimulative Policies

Depending on the selection of index denominated in US dollars, China’s shares market is returning either 2.5, (Shanghai Composite), 4.1 (MSCI China) or 18.3 percent (Shenzen Composite) since the end of last year.  So, what accounts for the huge disparity in performance?  The Shanghai and Shenzen Composite indices track the performance of all A- (resident-only) and B-share (foreign-only) classes on their corresponding exchanges.  Both are capitalization-weighted, yet neither yardstick of aggregate market valuation employs a free-float factor, meaning neither index excludes from its calculation cross-shareholdings or locked-in shares held by promoters and governments.

By contrast, MSCI’s China index (MXCN) – our preferred gauge – is a free-float weighted index that computes 

market capitalization based on the shares readily available in the market.  MXCN’s single-digit gain places China just behind the Bloomberg European 500 index or twenty-eighth in the global standings thus far in 2015, a far better outcome when compared with the 5.2 percent loss it experienced during the same time frame a year ago.

Yesterday’s commencement of the ten-day annual meeting of the National People’s Congress witnessed Premier Li Keqiang’s address to the ersatz parliamentary body on the current state of the domestic economy.  In setting a seven percent goal for real GDP growth this year – the slowest in fifteen years, Li acknowledged the erosive impact on domestic economic activity of increasing headwinds stemming from weak global demand for national exports as well as an incomplete rebalancing of the macro-economy from foreign to internal sources of growth.

The ongoing property slump, disinflationary pressures and surplus industrial capacity are also complicating the efforts of Beijing to put economic momentum on an expansionary trajectory.  In order to engineer a faster pace of growth for the macro-economy, the authorities plan to reinforce monetary stimulus with fiscal firepower.  On top of the two rounds of credit relaxation by the People’s Bank of China (PBoC), the regime intends to invigorate growth by augmenting official spending, thus expanding the budget deficit by 0.5 percentage point to roughly 2.3 percent of nominal GDP.

Li reiterated the Communist regime’s commitment to deepen economic and structural reforms.  Specifically, he reaffirmed the government’s pledges to: decentralize power to local political entities; undertake reforms of the investment and financial systems; accelerate price reform; ensure further reform of the fiscal and tax collection systems; institute further reforms of inefficiently managed state-owned enterprises in addition to the allocation of state capital; and transform foreign trade.  However, a notable absence of specificity is apparent regarding how Beijing planned to make changes in each of the aforementioned areas.  Li presented no detailed roadmap or timetable for achieving any of them.

The crackdown on official corruption, amid speculation that the wealth and power amassed by a close ally of and second-in-command to former President Jiang Zemin has come under official scrutiny, is expected to proceed apace as public investigators turn their attention to widespread indiscipline in the military – especially, in the People’s Liberation Army.  Fourteen senior officers have been placed under investigation of late on top of at least another sixteen, who President Xi Jinping’s anti-corruption campaign snared in an earlier round.

With no government institution or agency immune from investigation, two theories may explain Xi’s zeal for ferreting out corrupt politicians, bureaucrats and military officers.  On the one hand, the campaign is merely a pretext for Xi to accumulate more power, which would make him the most powerful Chinese leader since Deng Xiaoping.  On the other hand, the broad anti-indiscipline effort would eliminate all opposition to Xi’s and Li’s commitment to reforming a host of intractable economic problems – most importantly, unproductively operating state-owned enterprises.

Politics and anti-corruption inquiries aside, China’s macro-economy appears on course to reach its official target of growing seven percent in 2015, slowing to 6.7 and 6.5 percent in 2016 and 2017, respectively, according to median private-sector consensus estimates surveyed by Bloomberg.  Fiscal and credit stimulants should ensure that domestic demand more than compensates for any further anticipated decline in overseas purchases of Chinese exports notwithstanding any additional downward adjustment in the yuan engineered by the authorities.

Household consumption, now accounting for slightly more than half of nominal GDP, is likely to reinforce demand and effectively forestall economic activity from slipping below the government’s seven percent guidepost.  Additional lending rate reductions by the PBoC would give businesses the incentive to ramp up output via an expansion of plant and equipment.  Taken together, then, internal origins of economic growth are forecast to outweigh weakness emanating from abroad to enable the regime to fulfill its seven percent target.

Steady, yet comparatively strong, expected real GDP growth of about seven percent and government pledges to institute comprehensive measures for reforming the national economy, financial system and state-owned enterprises should help to fortify investor bullishness for Chinese shares in the months ahead.  Global Markets Intelligence (GMI), given the foregoing, retains its propitious view of the Chinese equity market and advises overseas investors to continue to concentrate their investments in infrastructure-related shares not related to housing or office construction and avoid banks and other financial services companies until the Beijing makes material progress toward a resolution of the overly leveraged property and credit bubbles.  Furthermore, GMI recommends foreign investors to direct a portion of their capital in the direction of the consumer discretionary sector as the national economy shift gears from foreign- to domestic drivers of demand.

Subscribe to Insights