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Phillip: Strike China While It Is Still Hot!
Aspire, Investments | 22 June 2015
By: Lim Si Jie
Articles (169) Profile

Morgan Stanley Capital International (MSCI) had a major decision to make this week: whether to bring Yuan-denominated stocks into its global emerging-markets benchmark. If A-shares had been included in the index, their weighting would be about 0.6 percent of the MSCI Emerging Markets index. This was a move estimated to add $400 billion to China stocks over time.

Although China A-shares were not added into the MSCI key emerging markets benchmark index, Phillip remains overweight on the Chinese market. China is expected to increase easing and fiscal spending to boost its fundamentals as well as potential links between stock exchanges in the region.

Delay In MSCI A Minor Hiccup

Although index provider MSCI announced their decision about not adding China A-shares into its key emerging markets benchmark index, at least not as soon as May 2017, it is just a matter of time before it gets included.

Rival index provider Financial Times Stock Exchange (FTSE) Russell has also signalled its intent to adopt a staggered approach by launching two transitional indexes, which will include China A-shares before bringing them into its emerging markets benchmark in the next two to three years.

With the authorities closely monitoring developments, reforms and stimulus measures should continue to offer more investment opportunities and drawing in demand for Chinese equities as China signals its willingness to fully open up its capital markets.

HK-SH Stock Connect Continues To Propel Markets

Despite the delay of the Chinese A-shares’ inclusion in the emerging markets index, the Chinese market continues to be buoyed by the Hong Kong-Shenzhen Stock Connect (HKSSC). Phillip expects the connect to happen towards to the end of this year.

It is speculated that Taiwan might be included in stock connects with China and Hong Kong too. Phillip expects Chinese stocks to continue trending upwards as the general sentiments remain positive about the synergy. More liberalising initiatives may even push the region to a “whole new platform”, Phillip thinks.

Easing Monetary Policy

Persistent deflationary pressure has kept real interest rates stubbornly high in the Chinese market. Real interest rates in China are over three percent, which is well above real rates in Japan, Europe and the United States where borrowing costs are negative.

With current reserve requirement ratio (RRR) at 18.5 percent, China also has a relatively high RRR compared to other major economies globally.

Phillip expects the central bank to cut the benchmark interest rate or RRR again this year to spur credit growth. There is even a possibility that the Chinese central bank might be cutting both benchmark interest rate and RRR should capital outflow continue at the pace of the first quarter.

Fiscal Spending On Infrastructure Investment

Looking forward, the Chinese government is expected to speed up infrastructure investment with enhanced support from policy banks. The “Belt and Road” Initiative (BRI) is a key priority of China’s foreign policy right now.

It aims to revive the ancient trade routes connecting China, Central Asia and Europe. China is prioritising development of two supply chains, namely the New Silk Road and the Maritime Silk Road. China wants to empower it to become a transportation hub as well as the heart of the BRI.

The implementation of the initiative will not only enhance trade and investment facilitation measures, infrastructure development (railways, highways, airports, ports, telecommunications, energy pipelines, and logistics hubs), but also industrial and sub-regional economic cooperation (primarily overseas industrial parks and economic corridors) as well as financial cooperation.

It will also facilitate capital and labour movement between countries linked by the New Silk Road and Maritime Silk Road. This will reduce overproduction and overcapacity issues, especially in steel and construction sectors, as China attempts to stimulate economic growth with fiscal spending.

Recommendation: Overweight On China

Phillip maintains an Overweight rating on China as there are still opportunities and positive prospects from reforms and liberalisation policies. Investors can expect a moderate rebound in 2H2015 as impacts from the rate cuts and targeted stimulus measures start to kick in.

The Chinese stock markets are also expected to remain in bullish mood as investors continue to bet on further easing from policymakers.

Expensive Valuation But Opportunities Aplenty

Although Phillip believes that Chinese stock valuations have become more expensive over the year, it foresees plenty of opportunities to enter the market.

Source: Bloomberg, Phillip

SHCOMP’s current valuation of Price-Earnings (P/E) ratio of 25x has crossed its ten-year average P/E of 19x. Forward P/E would average to 19.5x based on a 23 percent consensus forecast earnings growth. However, Phillip expects quick corrections and recoveries in near term as Chinese regulators enforce risk management control of the stock lending and margin financing businesses.

This could present opportunities for long term investors to pick up bargains and ride the strong uptrend in Chinese markets.

Investors can also consider investing in unit trust or Exchange-Traded Funds (ETFs) which tracks the Chinese market such as Fidelity Greater China, First State Regional China, db x-trackers MSCI China TRN Index 1C (LG9.SGX) and iShares FTSE A50 China (2823.HK).

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.


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