Lazard Insights
China’s Onshore Stock Market: Fiction, Fad, or the Future? Manish Singhai, CFA, Managing Director, Portfolio Manager/Analyst
Summary • After a flat trend from mid-2009 to 2014, China’s onshore stocks took off in late 2014.1 The market has given back most of these gains, but at the end of August 2015, it still had better 12-month returns than many other major markets. • The sharp decline in China’s onshore market prompted intervention and support by the Chinese government, and the subsequent devaluation of the renminbi drew greater attention from investors. • At more than $8 trillion in market cap, China’s onshore stock market represents a large investment universe. This market will gradually improve its investability and be included in global benchmarks. • There are structural drivers in the wider Chinese economy that will help transition to a new phase and provide opportunities for domestic companies. • The long-term significance of the onshore market is undeniable and represents an opportunity for active investors.
Lazard Insights is an ongoing series designed to share valueadded insights from Lazard’s thought leaders around the world and is not specific to any Lazard product or service. This paper is published in conjunction with a presentation featuring the author. The original recording can be accessed via www.LazardNet.com.
News flow from China has made Greece’s potential default feel like a distant event. China’s A-share market, a term commonly used to describe China’s onshore stock markets in Shanghai and Shenzhen, is at the epicenter of these headlines. Since late 2014 through June 2015, China’s A-share Index had more than doubled, only to give back most of those gains over the ten-week period that followed. The sharp decline prompted some aggressive intervention and support measures by the Chinese government. Even as the A-share market was trying to find its feet, the devaluation of the renminbi caught everyone by surprise and raised concerns of a competitive depreciation in emerging markets currencies. However, beyond these headlines there are important domestic and external structural initiatives that continue to solidify China’s onshore markets globally. In this paper, we will share a high level overview of the Chinese onshore stock market. We will look at: • The market’s size and structure, • The recent rally and crash, • The participants and drivers, • Structural changes, and • Index providers’ views on these changes.
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Exhibit 1 China’s A-Share Market Cap Is Second Only to the United States
Exhibit 2 Three Broad Classifications for Chinese Equities
1
China
Hong Kong
Japan
United States
United Kingdom
Market Cap ($T)
8.1
3.5
5.0
26.8
3.7
Listing Exchange
Turnover ($T)a
3.9
0.2
0.5
2.5
0.2
Stocks with Market Cap > $1B
Number of Listed Stocks
2,800
1,808
3,488
5,292
1,991
As of 31 July 2015
Membership in MSCI ACWI
2
3
Offshore
Offshore
Onshore
Hong Kong
United States
Shenzhen Shanghai
256
99
645
739
MSCI China Will be added Under consideration Index to MSCI China in November 2015a
a Calculated as monthly average YTD through July 2015.
As of 31 August 2015
Figures reported by LSE are used for the United Kingdom, NASDAQ and NYSE figures are used for the United States.
a This will lead to 17 additional stocks added to the MSCI China Index and 48 stocks added to the MSCI China IMI.
Source: London Stock Exchange, World Federation of Exchanges
Source: Bloomberg, MSCI
Is the Chinese A-Share Market a Real Player?
Exhibit 3 The A-Share Market Surged in Late 2014
By the end of the second quarter of 2015, China’s A-share market was the second-largest stock market in the world by market capitalization, and despite declining sharply in August, it retains its ranking. Yearto-date, the monthly average trading volume for the Chinese onshore market was nearly $4 trillion, which was significantly higher than the US market’s $2.5 trillion during the same time (Exhibit 1). In addition, the Hong Kong market, where the bulk of the overseas Chinese equities are listed, adds another $3.5 trillion in market cap, but trades at a more sensible $200 billion each month. While the Chinese A-share market appears to be running frenetically at certain points in time, we believe it remains a substantial and important market.
Shanghai Shenzhen CSI 300 Index
There are essentially three groups of Chinese equities—offshore equities listed in Hong Kong, offshore equities listed in the United States, and onshore equities listed in China, which we will be our main focus (Exhibit 2). Hong Kong–listed stocks, such as China Mobile, PetroChina, and Chinese banks, have been available to global investors for almost two decades. This group of stocks forms the MSCI China Index, which makes up roughly 20% of the MSCI Emerging Markets Index. Examples of US-listed Chinese equities include Alibaba and Baidu. It is important to note that these are primary listings, and some of these have been available to investors since the 1990s. The key difference is that these US-listed stocks, unlike the Hong Kong–listed stocks, are not currently part of any MSCI country index. However, MSCI has announced that these US-listed Chinese companies will be included alongside Hong Kong–listed stocks in the MSCI China Index by November 2015. Finally, the onshore markets in Shanghai and Shenzhen contain over 2,500 stocks, of which more than 1,000 have a market cap in excess of $1 billion.
One-Year Total Returns through August 2015, USD
After a mostly sideways market from mid-2009 to 2014, the Shanghai Shenzhen CSI 300 Index took off in late 2014 (Exhibit 3). The market has given back most of these gains, but through August 2015 it still has better 12-month returns than many other major markets. The buoyant market has benefited IPOs, the majority of which have performed well after listing. In addition, the market has been highly
6,000
4,000
2,000
0 2005 2006 2007 2008 2009 2010
2011 2012 2013 2014 2015
(%) 50 25 0 -25
CSI 300 Index
MSCI China Index
MSCI EM Index
S&P 500 Index
MSCI Europe Index
As of 31 August 2015 The performance quoted represents past performance. Past performance does not guarantee future results. Not intended to represent any product or strategy managed by Lazard. It is not possible to invest directly in an index. Source: Bloomberg
volatile since late-2014 and daily moves of +/-1% are common (Exhibit 4). In our view, this volatility is also a source of opportunities for stock pickers. The recent volatility in China’s onshore market has largely been driven by retail investors. In Exhibit 5, the top chart is the number of new brokerage accounts that have been opened in the last two-and-a-half years, plotted against the index. The market rally has coincided with a
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Exhibit 4 There Has Been Significant Market Action in China’s Onshore Stocks
Exhibit 5 China’s A-Share Market Has Been Driven by Retail Investors
CSI 300 Index Has Moved +/- 1% in 98 of the Last 165 Days
Millions
Days
4.5
New Account Openings Period in chart below
Index 6,000
75 3.0
4,000 CSI 300 Index [RHS]
50 1.5
25 0
2,000 New Brokerage Account Openings [LHS]
0.0 -7% to -9%
-5% to -7%
-3% to -5%
-1% to -3%
-1% to 1%
1% to 3%
3% to 5%
0 2013
5% to 7%
2014
2015
Margin Buying in 2015 Outsized Returns for Several IPOs Since Listing in 2015
Billions (RMB)
(# of IPOs by return)
95
75
150
CSI 300 Index [RHS]
0
50
100
-95
25 0
Index, January 2015 = 100
50
Daily Net Buying from Margin Financing [LHS]
-190 <100%
100% to 200%
200% to 300%
300% to 400%
>400%
0 Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
As of 2 September 2015
As of 31 August 2015 (new account data as of May 2015, margin data as of 27 August 2015)
The performance quoted represents past performance. Past performance does not guarantee future results. Not intended to represent any product or strategy managed by Lazard. It is not possible to invest directly in an index.
The performance quoted represents past performance. Past performance does not guarantee future results. Not intended to represent any product or strategy managed by Lazard. It is not possible to invest directly in an index.
Source: Bloomberg
Source: Bloomberg, Wind
very large number of new investors entering the market. The bottom chart shows how liberally retail investors used margin financing during this time. Importantly (on the right-hand side of the bottom chart) margin financing turned negative essentially as brokers tightened screws after the rally. Once the brokers tightened margin restrictions, the market dropped significantly. While there are enough indications that the government and regulators were concerned about the pace and gradient of the market rally, the sell-off seems to have taken them by surprise. In an effort to temper the free-fall, the government put together a number of measures that ranged from direct buying intervention to trading restrictions. That was also backed by ongoing monetary easing, with the People’s Bank of China (PBoC) announcing the fourth round of interest rate and reserve ratio cuts this year in late August. Unrelated to the equity market gyrations, a de-facto devaluation of the renminbi caught the entire market by surprise. The devaluation was initially interpreted as a move by the Chinese government to help its exports as economic growth has been flagging. In effect, this move accelerated a competitive depreciation in other emerging markets currencies (Exhibit 6). Subsequently however, the Chinese leadership has insisted that the move is a technical adjustment to align offshore and onshore renminbi markets, and help its bid for inclusion in the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) basket. We believe this explanation. First, export competitiveness gained through
Exhibit 6 The PBoC’s Devaluation of the Renminbi Hurt other EM Currencies The PBoC Devalued the CNY in August 2015 Index, 100 = May 2013 (inverted scale) 80 100 120 140
CNY
KRW
TWD
PHP
SGD
THB
INR
IDR
160 May 2013
Nov 2013
May 2014
Nov 2014
May 2015
As of 4 September 2015 Exchange rates are versus the US dollar. Source: Bloomberg
currency devaluation is almost always transient and the Chinese leadership is aware of this. Second, and more importantly, China has serious global financial leadership ambitions and it is very unlikely that they would use such a blunt tool to help bolster their economic growth.
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Beyond the Recent Moves: The Long-Term View on Onshore Equities So far, the multi-trillion dollar question is, “is this another boom and bust market cycle?” We believe that it is different this time given that there are several structural drivers in place. For the first time ever, foreign investors have practically unrestricted access to China’s onshore market. So, investors with a brokerage account in Hong Kong can buy stocks in Shanghai and soon, this access, known as the Shanghai-Hong Kong Stock Connect scheme will be expanded to include the Shenzhen exchange. Prior to this, the only way any foreign investor could gain access to the onshore market was through a qualified foreign institutional investor (QFII) scheme, which was cumbersome, and limited to select large institutional participants. The implications for global equity allocations are huge: the onshore market is bound to enter all major equity indices and given its size become a significant component over time. The most compelling draw about the onshore market is that it offers an attractive opportunity set; the volatility adds to the inefficiency of the market and thus provides potential rewards for active management. China’s stock market is broad and deep: there are well over 1,000 stocks with market cap in excess of $1 billion spread across a variety of industries (those over $5 billion are more concentrated in industrials and financials). The top ten stocks represent just 22% of the index (Exhibit 7). This results in a significant dispersion of returns within the market. For instance, from November 2012 to November 2014, the CSI 300 Index was down 5% but the median stock return was 7%. In our view, passive investing can be difficult in this market as tracking error will be high.
Domestic Initiatives The fundamental structural economic factors, both domestic and external, are another key aspect of China’s market. On the domestic front, Xi Jinping’s regime has initiated some meaningful reforms over the past three years. The impact of these reforms is now becoming visible. Reforms include: financial market reforms; fiscal reforms, such as the one that helped the banks deal with balance sheet concerns; the anti-corruption drive; social reforms, such as repealing the one-child policy; and state-owned enterprise (SOE) reform are all critical positive developments. SOE reforms are often overlooked by outside commentators. SOEs are a large part of the Chinese economy and make up 40% of the country’s GDP, employ 70% of its people, and are large constituents of both the onshore and Hong Kong–listed Chinese equities.2 There is evidence that the key issues, which have caused SOEs to lag the private sector over the past few years and have plagued the sector, are being addressed. The government is also actively reducing the number of SOEs by two-thirds. One large, high-profile merger that occurred
Exhibit 7 China’s Onshore Market May Be Attractive for Active Investors Large and Attractive Opportunity Set for Active Investors
• Broad and deep market: 1,384 stocks with market cap > $1B and 214 with market cap > $5B. • Largest 10 constituents of CSI 300 Index represent 22%, compared to 52% for the HK-listed MSCI China Index. Sector Distribution of Stocks with Market Cap > $5B Consumer Financials Technology Industrials Basic Materials 0
25
50
75 # of stocks
Onshore (Shanghai + Shenzhen) Offshore (Hong Kong + United States) As of 31 August 2015 Source: Bloomberg, MSCI
earlier in the year was a synergistic combination of two railway equipment contractors, CNR and CSR.
External Initiatives The second part of the structural reforms is China’s external initiatives. In the late 1990s and early 2000s, China created significant capital goods capacity, perhaps believing the country’s economy would grow by 10% forever. As they built out most of their infrastructure, this capacity has been incrementally idle. On the other hand, countries in Asia, such as Vietnam, Indonesia, and India and some in Africa still need to significantly build infrastructure, which is a potentially great demand source for this excess Chinese capacity. Therefore, earlier this year the Chinese government unveiled a mega-policy initiative called “One Belt, One Road,” in an attempt to forge and to fortify strategic economic ties with countries along the historical terrestrial and maritime silk roads. One issue related to matching this supply and demand of capacity was the source of the interim financing of the infrastructure build-out in these emerging and frontier markets. China had a solution for this issue, which also supports the country’s ambitions to be a financial super power. Since China only has a 4% vote in the IMF and 6% in Asian Development Bank, the leadership decided to create the Asian Infrastructure Investment Bank where China has 29% of the vote. In addition, they created two agencies to help finance Chinese equipment sales: the New Development Bank and the Silk Road Infrastructure Fund.
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Global Benchmark Inclusion Finally, one important development to watch is the manner China’s onshore equities will be included in global benchmarks. FTSE has two separate indices, including and excluding onshore equities, leaving the decision to the investor. On the other hand, MSCI is holding discussions with various stakeholders. It is likely that MSCI will initially include China A-shares at a very low weighting and then gradually phase it into a full weighting over time. Hypothetically at full weight, China’s total weight in the MSCI Emerging Markets Index would potentially double from current levels from about 20% to over 40%, and would reach almost 6% in the MSCI ACWI (Exhibit 8).
Conclusion At more than $8 trillion in market cap, China’s stock market is well diversified and a real global player. The Stock Connect scheme, launched in November 2014 to facilitate access for global investors to China’s onshore market, is a game changer, in our view. The access has coincided with significant positive structural initiatives and developments both in areas of domestic policy and externally in the form of the “One Belt, One Road” initiative and the Asian Infrastructure Investment Bank. Clearly, the onshore market is still developing, and thus it is not surprising that the market will be volatile in the foreseeable future. Therefore, government intervention in the market appears inevitable. While the extent and methods of this intervention are debatable, it should be viewed as an inescapable part of the development process. However, the long-term significance of the onshore market is undeniable and for a fundamentally driven active investor, the onshore market’s volatility actually may enhance this very attractive opportunity set.
Exhibit 8 China’s Onshore Equities May Significantly Alter Global Benchmarks Hypothetical Weight Scenarios MSCI EM Index
Weight (%)
China A
19.6
China Overseas
2.7
a
China H
20.2
South Korea
11.1
Taiwan
9.6
Brazil
5.9
Other
30.8
MSCI ACWI
Weight (%)
China A
2.7
China Overseas
0.4
China Ha
2.7
Other Emerging Markets United States Japan Other Developing Markets As of 19 May 2015 a Includes B, H, P Chip, and Red Chip shares Source: MSCI
China Total 42.5%
7.8 49.4 7.6 29.5
China Total 5.8%
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Notes 1 Represented by the Shanghai Shenzhen CSI 300 Index. 2 Source: Goldman Sachs
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