China’s domestically listed equity market – the Shanghai Stock Exchange and the Shenzhen Stock Exchange combined – is the world’s second largest after the US. With more than 3,000 listed A-shares now trading, it’s just too large for investors to ignore even as the trade war with America continues to cast a shadow over China’s economy.

How big is China’s domestic equities market?

Source: Bloomberg. Data as of July 18, 2019.
Bar chart shows the top three securities markets in the world as of July 18, 2019. U.S. market ranks top and China (onshore and offshore) comes next. Japan is the third largest stock market.

What, besides size, makes Chinese equities so attractive now?

  1. Demand is likely to increase as this market opens up to foreign investors and leading benchmark equity indices increase their A-share weightings.
  2. Government stimulus is likely to continue to support economic growth, creating a healthy environment for companies to increase their profits.
  3. Unique opportunities here allow investments in businesses and sectors that are not available in offshore markets, including Hong Kong.

Plans by MSCI and FTSE to increase the weightings of China’s A-shares in their emerging market (EM) equity benchmarks is a significant step toward integrating the country’s stock market into the global financial system. We believe these decisions mark the start of a trend that will see a multi-year increase in global fund inflows.

The decision by MSCI reflects the progress China has made in improving access to its mainland stock market. By 2020, around 20% of Chinese large- and mid-cap A-shares will be represented in its EM index. At that point, mainland Chinese stocks will make up around 3.3% of the benchmark. See “On the rise in EM indices.”

MSCI in June 2017 indicated that it might accept a higher proportion of A-shares if market access standards improve further. There are ongoing issues associated with the absence of sufficient risk management tools, omnibus trading accounts, trading holiday misalignment and trade settlement periods.

In the 19 months since MSCI’s announcement, the volume of assets flowing into the Shanghai Stock Exchange grew by $84 billion. We estimate that net fund inflows might be at least US$60 billion this year. The weighting of A-shares in the benchmark indices is likely to continue to rise, and would represent 37% of MSCI China index, if all stocks were included.

On the rise in EM indices

MSCI plans to increase the weighting of A-shares in its EM indices. Source: MSCI. J.P. Morgan Private Bank. Data as of March 1, 2019. 
Three pie charts show the changes of weighting of A-shares in MSCI EM indices from May 2019 to November 2019.

According to recent data, China’s economy may be slowing more than previously thought. Although trade negotiations with the United States have resumed, the two countries do not appear close to striking a trade deal and the threat of tariffs lingers. However, we believe earnings growth is bottoming out. At 12.5 times forward earnings, the market’s average price-earnings (p/e) ratio remains below its long-term average of 15 times, leaving room for a gradual rerating. See “Profit potential.” 

Profit potential

A-share forward PE valuations are still below their long-term average Source: Bloomberg. Data as of July 2, 2019.
Line chart shows the performance of CSI 300 index from 2005 to 2019.

Weaker purchasing manager index (PMI) figures in May and June appear to reflect the impact of trade tariffs on new export orders. Yet the Chinese government’s stimulus policies should help to pep up the economy. They include lower taxes and short-term interest rates to boost consumption as well as an increase in infrastructure spending.

China’s A-shares tend to be more sensitive to domestic government policies and less vulnerable to international market volatility (See “Trade tensions”). We expect additional stimulus measures to help revive sentiment and stabilize the renminbi, which in turn should help A-shares continue to outperform other Chinese equity markets.  See “Taking the lead.”  

Trade tensions

Tariff increases have weakened China’s PMIs. Source: National Bureau of Statistics of China, Bloomberg. Data as of July 2, 2019.
Line chart shows the manufacturing PMI and non-manufacturing PMI of China from June 2014 to June 2019.

Taking the lead

A-shares (CSI 300) have outperformed other Chinese equity markets this year. Source: Bloomberg. Data as of June 28, 2019.
Line chart shows the performance of CSI300 and MSCI China from January 2019 to June 2019.

The A-shares market comprises a broad range of companies, from traditional state-owned enterprises to some of the world’s most innovative businesses. Many of these sectors are not available in offshore markets, including firms at the leading edge of industrial automation technologies and infrastructure power grids to alcoholic beverage manufacturers. See “A well-diversified market.” 

A well-diversified market

Composition of China’s A-share CSI 300 Index. Source: Bloomberg. Data as of April 2, 2019.
Pie chart shows the composition of China’s A-share CSI 300 Index.
The difference between the composition of the MSCI China A Onshore and MSCI China (Offshore) indices highlights how investors have access to a greater range of opportunities in the domestic market (See “Top 10 holdings”). Notably, the top 10 constituents comprise half of the offshore index, which is dominated by Tencent (15%) and Alibaba (13%). Meanwhile, the top 10 constituents of the onshore index make up less than a quarter (23%), and Ping An is the largest holding (6%).

Top 10 holdings - MSCI China Index (Offshore)

Source: MSCI. Data as of June 28, 2019
Two tables show the top 10 constituents of MSCI China Index (Offshore) and MSCI China Index (Onshore).

Top 10 holdings - MSCI China A Onshore Index

Source: MSCI. Data as of June 28, 2019
Two tables show the top 10 constituents of MSCI China Index (Offshore) and MSCI China Index (Onshore).

We see many crown jewels hidden in A-shares that capture China’s unique growth prospects. If you'd like to include an allocation to Chinese A-shares in your portfolio, here are three ways to gain exposure:

  •  A CSI 300 exchange-traded fund (ETF) with some added downside protection.
  • Actively managed funds with overweight positions in A-shares
  •  Single stocks that can benefit from domestic economic stimulus policies.

If you’d like more information about the investment opportunities available in China, please contact your J.P. Morgan representative.