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Global Perspectives Weekly
China: Headed in the Right Direction
OCTOBER 22, 2014
In this Global Perspectives Weekly:
Peter Donisanu
Global Research Analyst
China’s Economic Retooling
Alex Kun, CFA®
Senior Investment Research Analyst
Hong Kong
Wisely Ngai, CFA®, CAIA
Investment Research Analyst
Hong Kong
» With the increasing risk of a global economic slowdown, China
tilts towards credit easing and additional economic reforms.
» The central bank implemented liquidity injection measures to
ease credit restrictions in the domestic housing market.
» The Shanghai-Hong Kong Stock Connect program is expected
to enhance market liquidity and domestic capital markets.
» We believe these economic retooling efforts are helping
China’s economy but execution of the reforms will take time.
We are maintaining our neutral recommendation on Chinese
equities.
The Fourth Plenary Session of the 18th Communist Party of China Central Committee is convening this week.
The meeting is expected to provide market observers an update on several reforms that were announced
during the third plenum last November. In addition, with the potential for slowing global economic growth,
China is continuing its economic retooling process while tilting towards credit easing in the housing market.
Having successfully curbed property speculation resulting from an overheating property market, the Chinese
government has started loosening housing market restrictions once again. Also, work on the Shanghai-Hong
Kong Stock Connect program is underway, aiming to deepen capital market reform and enhance market
liquidity. We believe that China will continue expanding its arsenal of economic reforms, but likely will
calibrate the pace and implementation of reform in response to changes in economic circumstances.
Credit easing in the housing market – In response to the slowdown in domestic home sales, the People’s
Bank of China (PBoC) rolled out policies to ease credit restrictions for borrowers. These adjustments
included four liquidity injection measures. First, for first-time home buyers, banks can charge mortgage
rates as low as 70 percent of the benchmark lending rate, reduced from a range of 90 to 110 percent of the
benchmark rate currently being charged for loans that extend beyond five years. This change helps reduce
financing costs for borrowers and maintains the maximum loan-to-value (LTV) ratio at 70 percent—meaning
that first-time home buyers are allowed to purchase a residence with a 30 percent down-payment. Second,
homeowners who already own a single property without a mortgage now can be considered “first-time
buyers,” granting them the 70 percent LTV ratio and possibly lower mortgage rates. Previously, mortgages
on additional properties were limited to 30 percent of the property value and the mortgage rate floor was
110 percent of the benchmark rate. Third, home-purchase restrictions have been relaxed in some cities.
Banks in certain regions are allowed to set the LTV ratio and mortgage rate based on a borrower’s solvency
and creditworthiness. This measure also applies to homeowners who have more than one property and
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Global Perspectives Weekly
have completely paid-off mortgages. And fourth, the PBoC supports property developers by encouraging
lenders to address developers’ financing needs. Lending banks’ efforts may include the following: assisting
qualified developers in issuing bonds to the fixed-income market, conducting pilot trials of real estate
investment trusts (REITs), extending loan tenures for social housing and resettlement projects to 25 years,
and issuing mortgage-backed securities while redeploying proceeds to increase mortgage quotas. In
essence, the goal is for lending banks to help induce demand and offset the excess supply in the housing
market.
Chart 1: PBoC benchmark lending rate
China 6 Months-1 Year Rate On RMB Loans - Interest Rates
7.5
Percent
7.0
6.5
6.0
5.5
5.0
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source: Wells Fargo Wealth Management; Factset, 10/17/14
Shanghai-Hong Kong Stock Connect program – In April 2014, Chinese Premier Li Keqiang announced that
the Shanghai and Hong Kong stock exchanges would become connected, allowing daily cross-trading
between the two exchanges. This program aims to further open the domestic market and enhance market
liquidity. With the current quota systems in place, this program will serve as an additional channel for
foreign capital to flow into the domestic equity market. This development is significant, as policymakers
work towards increasing the importance of the Chinese yuan as an international currency.
This program allows Hong Kong and mainland China investors to trade shares listed on each other's market.
But, all such trades must be transacted in Chinese yuan. Through the Northbound connect, foreign investors
can trade all constituents of the Shanghai Stock Exchange (SSE) 180 Index, the SSE 380 Index, and dual-listed
stocks in the Shanghai market. For the Southbound connect, mainland China investors can buy and sell all
constituents of the Hang Seng HK Large Cap Index, the Hang Seng HK Mid Cap Index, and dual-listed stocks
on the Hong Kong stock exchange. The initial daily aggregate quota limits for Shanghai and Hong Kong are
300 billion yuan and 250 billion yuan respectively. It is expected that the quota limits will be raised over time
and may be removed eventually.
Our view – Although concerns about global economic growth continue to mount, China’s exports grew at a
healthy pace of 15.3 percent on a year-over-year basis in September, their strongest level since January
2013. However, this improvement may have come at the expense of industrial profits growth, which slowed
from a year-over-year rate of 11.4 percent in June to 10 percent in August. Admittedly, the improvement in
exports during the month of September has helped China gain market share in global exports—China is now
the largest exporter of steel and iron. In fact, China’s overall export volume of steel and iron now accounts
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Global Perspectives Weekly
for about 10 percent of global market share according to the International Trade Centre 1. In addition, the
Producer Price Index (PPI) shrank by 1.8 percent in September, marking its 31st consecutive month of
contraction. Prices of materials, like coal, steel, and cement, continue to trend downward due to excess
capacity. At the same time, consumer demand has not yet reached a level allowing it to lead China’s
economic growth. Retail sales growth is still hovering around a relatively low level of 12 percent on a yearover-year basis.
The overall picture of China’s economy is mixed. We expect policymakers to respond to concerns about the
unevenness of growth in certain sectors of the economy with more policy adjustments and reforms, but not
necessarily broad-based stimulus measures like those implemented in 2009. Premier Li recently mentioned
the possibility of additional monetary and fiscal policy support to achieve the 7.5 percent growth target this
year. The current easing of credit standards in the housing market is an example of such a targeted measures
crafted by the government aimed at stabilizing certain sectors of the economy. So far, the impact of this
policy appears stronger than the market had anticipated. Moreover, if the Shanghai-Hong Kong Stock
Connect program is implemented successfully, we believe it will benefit the long-term outlook for Chinese
capital markets in spite of the near-term setbacks.
Chart 2: Shanghai A-shares premium over Hong Kong H-Shares index
105
Percent
100
95
90
85
A-Shares Premium Over H-Shares Index
80
Source: Wells Fargo Wealth Management; FactSet, 10/17/14. Heng Seng China AH Premium index.
Additionally, this week’s plenary session is expected to focus on the theme of “rule of law.” Generally
speaking, there are two focal aspects of the legal system to be considered. The first one involves respect for
the highest authority of the constitution in the state’s administration. The second seeks to make the judicial
system independent from administrative interference at the local level. The legal system in China most
assuredly requires reform. A mature legal system not only helps to build public trust in the leadership, but
also improves foreign investors’ confidence about investing in China. Although such reform is not directly tied
to fiscal or monetary policy, a sound legal system is critical to the success of the economic retooling process,
especially as China expands domestic markets and promotes internationalization of the yuan.
1
International Trade Centre, Trade Competitiveness Map, 2013
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Global Perspectives Weekly
Investment implications — The Chinese stock market has outperformed other global equity markets over the
past three months, and yet, it remains fairly valued. In fact, the forward price-to-earnings (P/E) of the MSCI
China Index is trading at 8.3 times forward earnings. This P/E is lower than those of other major emerging
markets, but reflective of investor concerns about China’s reform efforts and its progress in rebalancing its
growth strategy. The prices of companies listed as A-shares in Shanghai (priced in Chinese yuan) are still
trading at discounts relative to their H-share listings (priced in Hong Kong dollars) in Hong Kong, particularly
in the financial sector. We expect that the valuation gaps for cross-listed stocks eventually will narrow once
the Shanghai-Hong Kong Stock Connect program is fully implemented.
Chinese policymakers appear headed in the right direction through this latest series of policy adjustments
and reforms. However, we believe the administration will take a measured approach to adopting these
changes, prolonging the time for any effects to become evident. Meanwhile, we anticipate further setbacks
related to public policy and the markets’ response to them. Hiccups may also occur from time to time due to
a weakening macroeconomic environment in many parts of the world. This week we learned that China’s
third-quarter gross domestic product (GDP) for 2014 was 7.3 percent, slightly better than the 7.2 percent
forecasters were anticipating. This reinforces our view that the central government is keenly focused on
softening the potential blows that may accompany economic retooling efforts. For now, we maintain our
neutral view on Chinese equities.
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Global Perspectives Weekly
Weekly Capital Markets Activity (10/10/14 – 10/17/14)
Global Equity Markets
MSCI All Country
MSCI EAFE
DAX (Germany)
CAC 40 (France)
FTSE 100 (UK)
FTSE MIB (Italy)
IBEX 35 (Spain)
Nikkei (Japan)
MSCI EM
Shanghai SE (China)
BSE 100 (India)
KOSPI (South Korea)
BOVESPA (Brazil)
Mexico IPC
Wk
-0.9%
-0.7%
0.7%
-1.0%
-0.5%
-2.6%
-1.9%
-5.0%
-1.3%
-1.4%
-0.7%
-2.1%
0.7%
-0.4%
MTD
-4.8%
-5.9%
-6.6%
-8.7%
-4.7%
-10.5%
-8.0%
-10.1%
-2.8%
-1.0%
-2.0%
-5.9%
3.0%
-3.8%
YTD
-2.6%
-9.2%
-7.3%
-5.7%
-6.3%
-1.4%
0.6%
-10.8%
-2.5%
11.6%
23.5%
-5.5%
8.2%
0.7%
Global Sovereign Bond Market
Commodity Prices
Italy
Spain
France
Germany
Greece
Portugal
UK
US
Japan
India
Energy
Brent Crude Oil $/bbl
Natural Gas $/MMBtu
Agriculture
Corn $/bushel
Soybean $/bushel
Precious Metals
Gold Spot $/oz
Silver Spot $/oz
Industrial Metals
LME Aluminum $/Mt
LME Copper $/Mt
Livestock
Lean Hogs $/lb
Live Cattle $/lb
Yield Wk Chg (BPS)
2.50
17.4
2.17
10.3
1.30
4.6
0.86
-2.8
7.93
140.3
3.30
34.6
2.19
-2.8
2.19
-8.7
0.48
-2.9
8.39
-6.6
Price
-$86.2
$3.77
-$3.48
$9.52
-$1,238
$17.27
-$1,956
$6,689
-$0.91
$1.65
WK
-3.3%
-4.9%
-2.4%
1.4%
4.2%
3.2%
1.1%
1.2%
-0.7%
-0.8%
2.8%
-0.2%
-2.7%
-4.1%
-0.2%
Commodities
Headline Equity Markets
One-week Change
Mexico IPC
BOVESPA (Brazil)
KOSPI (South Korea)
BSE 100 (India)
Shanghai SE (China)
MSCI EM
Nikkei (Japan)
IBEX 35 (Spain)
FTSE MIB (Italy)
FTSE 100 (UK)
CAC 40 (France)
DAX (Germany)
MSCI EAFE
MSCI All Country
Ag 1.4%
Livestock -2.7%
PrecMet 1.1%
IndustMet -0.8%
Energy -3.3%
Gra phi c repres ents the a vera ge
s ector wei ghts of the S&P GSCI,
Rogers Interna ti ona l Commodi ty,
a nd Bl oomberg Commodi ty i ndi ces
a s of 10/17/14. Energy – 49%;
Agri cul ture – 26%; Preci ous Meta l s
– 12%; Indus tri a l Meta l s – 9%;
Li ves tock – 4%. Da ta i n thi s gra phi c
repres ents the one-week cha nge
i n s ector pri ce a ccordi ng to thei r
res pecti ve Bl oomberg Commodi ty
Index Fa mi l y.
-6% -4% -2% 0% 2% 4%
Currency Table (Pairs)
Currency Table (Change in Pairs)
Cross rate as of 10/17/14
One Week Change: 10/10/14 - 10/17/14
USD
EUR
BRL
CNY
AUD
CAD
CHF
GBP
1.28 17.26 78.78 3.11
MXN
7.83
1.46
1.44
1.21
0.79 136.4
0.58
0.13
INR
JPY
EUR
EUR
USD
MXN
INR
BRL
CNY
AUD
CAD
1.1%
1.4%
1.4%
1.3%
0.9%
0.4%
1.8% -0.1% 0.9%
CHF
0.0%
1.4% -0.4% 0.6%
JPY
0.01
0.58
0.02
0.06
1.07
0.01
0.89
0.73
JPY
0.7%
1.6%
1.3%
2.0%
0.6%
GBP
1.61 21.76 99.0
3.92
9.86
1.84
1.82
1.52
172.0 1.26
GBP
0.1%
0.4%
0.6%
0.4%
0.0% -0.6% 0.8% -1.0%
1.19
0.66 113.0 0.83
CHF
1.1%
1.5%
1.6%
1.9%
1.4%
0.84
0.55 94.78 0.69
CAD
-0.7% -0.4% -0.1% 0.4% -0.8% -1.4%
CHF
1.06 14.29 65.23 2.57
6.50
1.21
CAD
0.89 11.99 54.71 2.16
5.43
1.01
AUD
0.87 11.83 53.98 2.13
5.36
CNY
0.16
2.21 10.03 0.40
BRL
0.41
5.55 25.12
INR
0.02
0.22
MXN
0.07
USD
0.04
4.53
0.19
0.99
0.83
0.54 93.46 0.69
AUD
0.7%
1.1%
1.0%
1.0%
0.18
0.15
0.10 17.45 0.13
CNY
0.1%
0%
0.3%
0.4%
2.52
0.47
0.46
0.39
0.26 43.89 0.32
BRL
-1.0% 0.0% -1.3%
0.10
0.02
0.02
0.02
0.01
1.74
0.01
INR
-0.1% 0.5%
7.90
0.06
0.18
0.45
0.08
0.08
0.07
0.05
13.52 61.44 2.44
6.13
1.14
1.13
0.95
0.62 106.9 0.78
Thi s ta bl e repres ents a cros s -currency pa i r i n a ma tri x forma t. The
col umn on the l eft denotes the l oca l currency a nd the row a t the top of
the ta bl e the forei gn currency. For exa mpl e, i f the l oca l currency i s EUR
(euro) a nd the forei gn currency i s USD (U.S. dol l a r), then 1 euro buys
$1.28 U.S. dol l a rs (a s of 10/17/14).
MXN -0.3%
USD
0.6%
0.5%
1.9%
GBP
JPY
EUR
0.3%
-0.3%
-0.6% -0.9%
1.1%
0.4%
0.1%
-1.8% -0.8% -1.4% -1.8%
1.4% -0.4% 0.6%
0.0% -0.3%
-0.6% 0.8% -1.0% 0.0% -0.6% -0.9%
-0.3% -0.9% -0.6% -1.3% -1.2% -1.0% -1.3%
1.3% -0.3% -1.1% 0.5% -1.3% -1.0% -0.7% -1.0%
-0.3% 0.0% -0.4% -0.9% 0.5% -1.4% -0.4% -1.1% -1.2%
0.3%
0.2%
0.3% -0.1% -0.7% 0.7% -1.1% -0.1% -0.7% -1.0%
Thi s ta bl e repres ents the one-week cha nge for a gi ven cros s -currency
pa i r. A pos i ti ve va l ue i ndi ca tes tha t a l oca l currency ha s a ppreci a ted (or
you ca n buy more of a gi ven forei gn currency). The i nvers e i s true for a
nega ti ve va l ue.
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Global Perspectives Weekly
All data in this Global Perspective Weekly was sourced from Bloomberg unless otherwise noted.
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Global Perspectives Weekly
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