Chinese Stocks Weightings Boost in Tech Stocks Bonanza

Mar 2, 2019
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Chinese stock markets rejoiced on Friday to news that major emerging markets index specialist MSCI will be boosting the weighting that Chinese domestic equities (‘A’ Shares) enjoy in their indices. This marks an important win for China as it seeks to continue to modernise its economy and ramp up its importance on the global financial stage and could lead to as much as $125 billion in additional capital flooding into the Chinese equity markets in the coming year or so as MSCI ramps its weightings of Chinese A shares from the current 5% to 20%.

Chinese tech board ChiNext is also likely to see additional inflows. The Chinese equivalent of the Nasdaq board, aimed at technology companies and tech startups should also see some boosts from inclusion in the MSCI indices in 2019. Further boosted by the delaying of US tariffs on China to an as yet undetermined date, things seem to be looking up for tensions between the US and China de-escalating in light of Chinese concessions on Yuan valuation and commitments to up agricultural imports.

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What does this mean though for those of us who love all things tech? Easier access to capital markets for Chinese firms likely means a better ability to raise capital and produce better technology products. However if the Yuan is indeed allowed to appreciate against the dollar, that will jointly drive China to import more as well as make Chinese products more expensive for export. Although the general cost of Chinese assembly in a lot of technology products is a relatively small piece of the overall final cost of technology products, inflation in any part of the value chain will of course lead to an increase in cost facing the end consumers.

Indices as Drivers of Finance

For those unaware, inclusion in indices can be major drivers of stock prices, particularly given the rise of tracker funds which seek to emulate the returns of “the market” and are typically marked against a big index. Investors who decide they don’t want to pay an active fund manager to pick stocks and sectors for them when many of these fund managers fail to outperform the main index of their market on a regular basis see the additional costs of an active fund manager as anathema and so often pile their money into tracker funds which just basically take the same weightings and stocks that make up an index’s constituents. No expensive fund manager needed and returns will be in line with the index itself.

What this means is that when an index changes its constituents or weightings, major inflows or outflows of capital can become commonplace as funds seek to reposition themselves to continue to emulate the index they are supposed to be returning value against to the investor, so a boost as MSCI said to Chinese equities from 5% to 20% in its weightings over the course of this year is a big change.

China has faced a number of barriers (despite being the 2nd largest economy in the world these days) to seeing its capital markets support these kinds of wins. Chief amongst them has been the quite strict capital controls imposed on foreign investors and the lack of easy access to Chinese markets for foreigners. Hong Kong is of course an exception given its historical British rule and the Hong Kong market is generally aligned with western financial business practices, but Hong Kong has long been closed to mainland Chinese companies looking to access capital markets, leaving the main bourses of China as their only recourse.

This has brought additional difficulties with it however given that the main Chinese markets have relatively little foreign institutional funds invested in them due to the difficulties in gaining access as well as the lack of traditional hedging instruments like derivatives has meant that a lot of western funds haven’t been able to invest in them to the extent that they would otherwise have. A lack of major institutional investors has also led to a fairly heavily momentum and sentiment driven financial environment with less focus on company fundamentals and more on the latest news headlines driving retail investors to buy or sell which has contributed to the significant volatility associated with Chinese capital markets.

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Final Note – Caution to be Maintained

As we’ve written in the past, China is still a slightly dangerous proposition from an investment perspective. Chinese growth in recent years has been predicated upon debt and in some ways this is still being perpetuated, particularly given that the People’s Bank of China has loosened requirements on capital adequacy for the country’s banks twice in the last year. These are the kinds of smoke and mirrors employed when the merry go round is slowing down and government wants to keep things going for a few more rounds.

Any major stresses in the global economy could exacerbate the debt black hole that likely exists in the Chinese economy and these kinds of papering over the cracks measures would be exposed for what they are in the stark light of an economic downturn.

Despite strength on the surface, the US economy also has signs of struggling undercurrents, including increasingly distressed auto-loan numbers, Fed walkbacks on balance sheet unwinds and tightening of monetary policy as well as slightly weaker unemployment data than expected.

The talk of a deal between the US and China is increasingly important for both sides. It’s still worth remembering that we’re in the midst of one of the largest market bull runs in the last century (11 years and counting) although the underlying economic realities in terms of real wage growth haven’t materialised to the extent that the global economy has recovered from a capital markets perspective.

Increased investor exposure to a Chinese economy which may or may not be on the brink of an over-leveraged collapse may bring about better gains for investors if the music keeps playing but it feels quite late in the economic cycle to be making significant strategic bets on emerging markets.

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