As China rises as a global economic power, its capital markets are also evolving at a great pace. The combined Chinese equities market, represented by the Shanghai, Shenzhen and Hong Kong stock exchanges, has become the second largest market in the world behind the New York Stock Exchange, totalling more than $12 trillion in market capitalisation as at the end of 2017.
In the past, it has been difficult for SMSFs to tap into this strong growth due to Chinese restrictions on foreign investment in mainland-listed stocks. But recent regulatory changes have provided offshore investors with new access to China’s domestic stock markets.
As a result, interest in the stock of mainland China-based companies (Shanghai and Shenzhen), known as A shares, is rising among investors in Australia and around the world.
Chinese shares take the global stage
Two major developments in recent months have confirmed China’s commitment not only to greater openness and access to the Chinese economy, but to an acceleration of that process.
Firstly, the China Securities Regulatory Commission quadrupled the daily quota available for trading through the Stock Connect program to RMB52 billion (A$10.6 billion) from RMB13 billion (A$2.6 billion) from 1 May 2018. Stock Connect, launched in 2014, is a link between China’s mainland markets (Shanghai and Shenzhen) and the Hong Kong Stock Exchange that allows foreigners to buy A shares with fewer restrictions.
Secondly, China’s new central bank chief, Yi Gang, announced plans to remove limits on foreign ownership in the financial industry sooner than expected.
An important outcome of China’s moves to open up its market to foreign investors is that MSCI added 226 yuan-denominated, locally listed Chinese companies to its MSCI Emerging Market Index on 1 June 2018.
The inclusion in the index puts China A shares on the global stage as an investable market and signals China’s regulatory environment, liquidity environment and accounting principles are satisfactory for investors.
Any investor who is underweight China in the coming years will significantly underperform global equity indices, especially as Chinese equities are likely to be included more meaningfully in global indices in future after years of under-representation.
For Australian investors, it makes good sense to geographically diversify their investment portfolios to obtain some exposure to this market, particularly with the knowledge the Australian economy is tracking at a relatively lower pace.
At Saxo Capital Markets, in response to strong investor demand, we recently added China A shares to our trading platform, enabling our clients to trade stocks on the Shanghai, Shenzhen and Hong Kong exchanges via Stock Connect.
Secular growth themes: riding the consumption wave
Negative sentiment around rising United States-China tensions has contributed to a recent sell-off in the market, creating an opportunity for long-term investors to take a position in the market.
Chinese stocks have never been so cheap relative to the US. Earnings estimates remain strong and demographic trends in China will also supersede the impact of the business cycle and any trade war fears. History shows us any time the Shanghai composite has sold off so drastically, 12 months later the index is trading at a higher level.
Between 2009 and 2030, China will add 850 million people to its middle class, according to Organisation for Economic Co-operation and Development projections. This means the Chinese middle class will grow from 12 per cent of its population in 2009 to 73 per cent in 2030, fuelling demand for jobs, education, apartments and services, and boosting purchasing power.
Another secular growth theme could come from China’s lower-tier cities as they become larger and wealthier and inject further consumption potential and vibrancy into the economy, thus stimulating the stock market in the long term.
Sectors such as telecommunications services, infrastructure, consumer staples and the large state banks should benefit from these secular growth themes and outperform through any correction.
High-quality companies, running at lower leverage and offering good growth potential, will be the safest bets. Public companies in the consumption sector with a global vision and a higher level of automation, e-commerce companies, high-end manufacturing companies and healthcare companies could all be good picks.
For the Chinese technology sector, regulatory protection by the Chinese government and a growing domestic market ensures growth in this industry will not be derailed by a global trade slowdown. China’s online user base increased to 772 million as at 31 December 2017, according to the China Internet Network Information Centre, which is double the population of the US, and there is still room to grow. Recent data suggests only 54.6 per cent of the population in China is online compared with 88.1 per cent in the US. We expect internet penetration and sector revenues to continue rising in the coming years as adoption increases.
A mighty force
China has outlined its plans to become a world superpower within the next 30 years and to overtake the US.
Chinese President Xi Jinping, speaking at the National Congress late last year, said it was time for China to become a “mighty force” that would lead the world on political, economic, military and environmental issues.
China has already advanced more than the western world gives it credit for. The One Belt One Road initiative, Made in China 2025 and the Shanghai Cooperation Organisation are all representative of the growing importance of China on the world stage.
As US President Donald Trump makes the US an unreliable partner in globalisation, China is poised to pick up the slack with the One Belt One Road initiative becoming a new venue for multilateral trade.
As Xi Jinping amps up China’s imperial ambitions, the US deficit deteriorates and the country follows an inward looking America first policy. This important trend will reshape geopolitical paradigms and the world order in a way few have yet registered, providing global recognition for China’s financial markets.
As Chinese capital markets are opened, global investors have an opportunity to participate in what will arguably be the biggest transformation of the century.
Ben Smoker is chief executive of Saxo Capital Markets Australia.