Ok, well, China’s official manufacturing gauge missed estimates for February, printing 49.2 versus consensus 49.5 on Thursday.
That’s not great and the trade indicators underscored ongoing concerns, as the imports subindex dove to 44.8 and the new exports gauge hit 45.2. Those are the lowest prints since the crisis.
The non-manufacturing PMI fell as well, dropping to 54.3 this month, from 54.7 in January.
Analysts pointed to some signs of stabilization and there were the obligatory nods to holiday distortions. To be fair, it’s probably best to wait for next month to see if ostensible “progress” on the trade front helps shore up sentiment and also to give the recent credit “binge” time to work its way through and manifest itself in real economic outcomes.
But while we may have to wait a while to determine whether the Chinese economy has in fact “bottomed”, nobody is waiting to load up on Chinese stocks.
In fact, the SHCOMP is the best performing major equity index on the planet this month, up a remarkable 14%, the best month since April 2015 (or, more to the point, the best month since just before the bottom fell out on the country’s margin-fueled stock bubble leading to one of the most harrowing crashes in recent memory).
Meanwhile, the ChiNext posted an absurd 25% gain this month. That, folks, is the best month on record for the tech/small cap gauge.
Obviously, part of this is attributable to movement on the trade talks and also to a relatively stable yuan (and the promise that a trade deal will include a commitment to continual currency stability).
But beyond that, signs that China is stepping back from its deleveraging push have bolstered risk taking. As a reminder, the shadow banking complex woke up in January, expanding for the first time in 11 months. Meanwhile, a new securities regulator (in Yi Huiman) has emboldened investors thanks to the assumption that his approach will be less heavy-handed than his predecessor.
Whatever the case, the result is a mammoth rally in onshore markets, which raises questions about whether it should be faded. According to SocGen, the answer is “no” – or at least not yet.
On Thursday evening, market participants will find out whether MSCI has decided to up the weight of A shares in global indices. Here are the key points as detailed by SocGen in a note dated Wednesday:
On 28 February, following a six-month consultation period with market participants, MSCI will announce its decision to further increase the weight of China A shares in international indices. The consultation covers three subjects:
- Increase the inclusion factor from 5% to 20% . If MSCI decides to proceed, this will be implemented this year in May and August (7.5ppt in each phase) this year.
- Add ChiNext to the list of eligible stock exchange segments (timing: May 2019).
- Add China A Mid Cap securities with a 20% inclusion factor in one phase (timing: May 2020).
The first subject is potentially the most significant. A quadrupling of the inclusion factor would increase the weight of domestic shares from 0.7% to 2.8% . If China A Mid Cap shares are included, the weight will increase to 3.4%
Obviously, a favorable decision on that first bullet point would mean inflows, the scope of which SocGen estimates at between $20 billion and $80 billion. Goldman puts the figure at $60 billion “assuming all mandates to market-weigh China A vs. their respective benchmarks.”
For context, SocGen notes that net inflows via the Northbound link have averaged $4.7bn/month since April of last year. Also notable, trading suspensions have been relatively rare during the recent market malaise, marking a stark contrast to the 2015 experience when Beijing essentially halted the entire market when things got really choppy.
As alluded to above, SocGen doesn’t think it’s time to “sell the news” just yet. They cite valuations and resilient earnings in the face of a challenging backdrop as well as the myriad efforts Beijing is making to support the domestic economy (with an emphasis on private enterprises).
“The CSI 300 trades at just 13.4x trailing earnings, a 15% discount to the 10-year average and unlike other large Asia equity markets, earnings have so far been resilient as the share of profit generated abroad is not significant”, the bank writes, adding that A shares should “continue to outperform the China offshore market” thanks to more attractive valuations “and the exposure to the consumer, a likely beneficiary of CNY stabilisation.”
For their part, Goldman agrees on the valuation point. “As of Feb 26, China A trades on 11.6X fP/E on a headline index basis, 14.1X ex-banks, and 11.2X ex-tech, all roughly at or slightly below their respective mid-cycle levels”, the bank writes, in a Wednesday note, introducing the following set of visuals which together serve to drive home the point:
Goldman strikes a more cautious tone on earnings than SocGen, though, noting that “profit warnings have turned less positive in 4Q compared to past quarters, suggesting limited room for upside surprises.” That said, they do say that at least on the Mainland, investors may have already priced in some of the downside.
For what it’s worth, the bank attributes a little less than half of the YTD surge in Mainland shares to trade and the yuan. You’ll note from the following chart that the “residual” category (i.e., “other”, non-fundamental factors) is especially pronounced. On that, Goldman says that in their view, “the potential other factors may include the stabilization in shadow banking liquidity, MSCI inclusion developments, and policy easing measures that could have direct implications on asset markets.”
So, what do you think? Is it time to fade the world’s best performing equity market on the heels of an astonishing February rally and ahead of a key index inclusion decision?
I’m just kidding – there’s no telling. Outside of a simple argument based on valuations, it is almost impossible to make a decision about this that is any semblance of “informed.”
The trade talks could lead to a comprehensive deal in relatively short order if Trump is in a “chocolate cake” mood, or they good drag on indefinitely in line with Bob Lighthizer’s rather cautious comments before the House Ways and Means committee on Wednesday.
Meanwhile, China’s efforts to bolster the domestic economy could be a smashing success depending on just how “pedal-to-the-metal” they want to go, or things could continue to decelerate as credit creation bumps up against the law of diminishing returns thanks to sky-high leverage, reduced demand for credit and a still-clogged transmission channel.
In other words, your guess is as good as anyone’s in terms of what comes next.