China’s A-game

The global sharemarket landscape is continually changing and one of the best performers over the past year has been China A-Shares. Playing a central role in China’s stock market, China A-shares are companies listed on either the Shanghai or Shenzhen stock exchanges with share prices denominated in Chinese yuan. Traditionally they have only been accessible to domestic investors in China, however since 2002, the China Securities Regulatory Commission (CSRC) has gradually opened the door to foreign investors via their Qualified Foreign Institutional Investor (QFII) program.

What is behind their surge?

Chinese retail investors traditionally invested in property and wealth management products issued by banks due to the attractive returns on offer. However, both a softer property market and defaults on wealth management products in 2014 (an attempt by regulators to stop these products being advertised as low risk) have seen retail investors increasingly turn to equities.

The CSRC introduced the Shanghai-Hong Kong Stock Connect program in November 2014. This program permits investors with a Hong Kong brokerage account to buy shares in a large number of A-Shares companies, and vice versa, further opening this market. Since the start of December 2014 there has been a staggering increase in the number of brokerage accounts opened by Chinese retail investors – equalling the combined total number opened in 2012 and 20131. And just last month, the People’s Bank of China (PBOC) also lowered the reserve requirement ratio for all banks by one per cent - the largest single liquidity creation step since the height of the global financial crisis, which has further spurred the stock market.

The wealth effect for investors

The intention of Chinese authorities clearly seems to have been to generate a ‘wealth effect’ – that is to make investors wealthy from stock market gains and for this to act as catalyst to encourage spending to support the country’s transition from an export-driven economy to a consumption-led economy.

Can this momentum continue?

Valuations (particularly at the riskier end of the market) look expensive, prompting concerns over whether prices are entering bubble territory or at least whether the momentum is sustainable. China A-Shares also experienced a boost in margin lending in 2015 and total margin positions are now greater than three per cent2 of total market capitalisation – a larger proportion of total market capitalisation than most of the major stock markets globally. Investors should be cautious as this is very much a liquidity-driven share market and a drain of liquidity would likely cause significant unwinding of these margin positions.

China also needs to address concerns over systematic risks, such as a run on the yuan. As either participants or spectators of Australia’s residential property market, especially in Sydney, most of us have witnessed firsthand the degree to which capital outflows are occurring. If the Chinese economy were to follow its more recent trajectory, this could result in a sharp reversal in Chinese equities.

Given the recent performance of and valuation uplift in mainland Chinese equities, it is necessary for investors to consider adjusting their return expectations. However, a key risk to the upside will be a continued opening up of Chinese markets and if China can successfully meet accessibility criteria set over the next few years, then mainland Chinese shares could make up a large component of global equity indices. This would undoubtedly result in significant capital inflows from foreign investors.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.

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