The Chinese government is learning from experience how to best build a more stable, healthier stock market
By Mike Shiao, Chief Investment Officer, Greater China
Along with global markets, offshore Chinese equities (MSCI China Index) were shaken up by developments in mainland China, losing -8.8% in the first four trading days of the year. The mainland China A-shares (CSI 300 Index) corrected -13% in the same period.
Circuit breaker and its prompt suspension
The recent market volatility could be explained by a few reasons. The new circuit breaking mechanism being triggered was the most apparent one, where trading was halted for the entire day after a +/-7% move in the CSI 300 Index. During the first week of January, a-7% move triggered the circuit breaker twice.1
In our view, the circuit breaker mechanism was not introduced at the right time - as global markets were already volatile after the US Federal Reserve's rate hike in December. This is an example of an "unintended consequence" of Chinese government action. As with many young markets with a large retail presence (over 85%), A-shares markets are often more driven by sentiment than underlying fundamentals. Together with the painful experience from China A-share market volatility during the summer of 2015, mainland investors panicked with the aim to sell their stock holdings before getting trapped when the circuit breaker was triggered. Subsequently, the suspension of the circuit breaker took place on Jan. 7, 2016, and was, in our view, a prompt and appropriate decision. It is evident the Chinese government is still learning from experience how to best build a more stable, healthier stock market going forward.
Renminbi depreciation - more reflective of market forces
Another contributor to the market volatility was increased concern on the pace of renminbi (NYSEARCA:RMB) depreciation. The RMB already lost -1.5% versus the US dollar since the beginning of the year as of Jan. 7. Since the inclusion of RMB into its basket of Special Drawing Rights (SDR) currencies on Nov. 30, 2015, the Chinese government allowed the currency to depreciate more rapidly. Yet, the Chinese government may have further room for improvement on the execution where it may have underestimated the market reaction to the move. In any case, we believe the depreciation of RMB makes sense given the intention is to liberalize the currency to better reflect market forces going forward.
No change to our structural views on China
In our view, it is sensible to see market volatility from time to time, as China is rebalancing its economy to a "new normal" and more sustainable long-term growth. Rather than focusing on short-term market developments, we believe in taking a long-term approach to investing in China. The transition will take time, leading to bumpy rides at times. That said, despite the recent market volatility, there is essentially no change to our structural views on China. Looking ahead, we believe China is heading in the right direction while seesawing between growth and reform. China's transition will unfold with a greater role for consumption, with further structural reforms being carried out in parallel.
H-shares in a better position
With the equity market trading in mainland bourses mainly made up of retail investors, who can be very momentum driven, it is not surprising to see volatile market swings for China A-shares. In contrast, offshore Chinese equities (MSCI China Index) tend to be less volatile given the higher percentage of institutional and international investors who seek to tap into Chinese equities via H-shares. In my team's view, H-shares are much better positioned than A-shares with more attractive valuations (10x 12-month forward PE) and a more diversified investor base. In terms of our investment strategy, through bottom-up stock selection, we continue to seek companies with industry leadership and competitive advantages. In fact, we would see periods of market volatility as presenting great opportunities to accumulate quality stocks at even more attractive valuations.
Read more blogs from Mike Shiao.
Learn more about the Invesco Greater China Fund.
Forward price-earnings ratio is one measure of the price-earnings ratio calculated with forecasted earnings, usually for the next 12 months or next full fiscal year, rather than current earnings.
The CSI 300 Index is a free-float weighted index that consists of 300 A-share stocks listed on the Shanghai or Shenzhen Stock Exchanges.
The MSCI China Index is an unmanaged index considered representative of Chinese stocks.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Investments in companies located or operating in Greater China are subject to the following risks: nationalization, expropriation, or confiscation of property, difficulty in obtaining and/or enforcing judgments, alteration or discontinuation of economic reforms, military conflicts, and China's dependency on the economies of other Asian countries, many of which are developing countries.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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