The headwinds Chinese equities faced in 2018 are a constructive backdrop for 2019, in our view.
 

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Low historical correlation to both DM and EM, along with a high retail investor base, may provide an opportunity in China’s state-owned enterprises.
 

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On 1 March, MSCI announced that it was increasing the free-float inclusion factor for China A (onshore Chinese shares) from 5% to 20%, in a 3-stage implementation in June, September and December this year. This could result in a notable increase in active and passive foreign fund inflows, with estimates reaching about USD100 billion, according to Bloomberg.1

China A is the best-performing major market this year through March 5, up more than 30% in USD terms (Figure 1). As argued in a January note, we believe the headwinds China faced in 2018 have turned to tailwinds, and the fundamental opportunity in China A is attractive, even after such a big move. Indeed, some of our tactical models suggest the market is due some correction/consolidation, which could open a compelling window.

China A is a particularly fertile environment, in our view, as there are inefficiencies in liquid stocks and we feel there are a wealth of conservatively-run, organically growing, cheap businesses. In principle, we believe this is an attractive alpha investment opportunity.

We believe we are having a rare moment where the stars have aligned for China A: the potential flows, improving growth prospects and the still-compelling valuations make for an attractive beta opportunity, in our view.

Figure 1. China the Best-Performing Major Market in 2019

Source: Bloomberg; between 1 January 2019 and 5 March 2019.

1. https://www.bloomberg.com/news/articles/2019-03-01/msci-s-latest-china-call-positive-but-mostly-symbolic-analysts

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