China fundamentals improving, says ETF provider Source

Apr 28th, 2016 | By | Category: Equities

Positive first quarter economic data from China suggests the market is well positioned to find favour with investors in 2016, according to exchange-traded fund provider Source. While Q1 GDP growth at 6.7% was a touch below the 6.8% of the previous quarter, the much feared collapse in China appears not to have occurred.

Chinese fundamentals improving, says ETF provider Source

Source believe that strong economic data from China’s property, industrial, and retail markets show that a potential stalling of the economy has been averted.

Investment spending has grown 10.7% year-on-year to March 2016, while industrial production rose 6.8% and retail sales climbed 10.5% in the same time period. Aggregate financing also rose to CNY6.5tn in Q1, up from CNY4.6tn a year ago. This is perhaps the best indication that local financial institutions believe the economy will expand over the medium term. However, the sharp increase in aggregate financing may also be viewed negatively by some investors who perceive it as further increasing China’s already ballooned debt pile.

These figures indicate that life remains in the Chinese economy despite sharp stock market declines from June – August 2015 and in January this year. Source believes continued positive economic data from China may begin to drive an uptick in foreign investment activity.

Paul Jackson, Head of Multi-Asset Research at Source, said in a statement: “There currently seems little enthusiasm for Chinese stocks among either foreign or domestic investors but that could quickly change. While the 43% top-to-bottom decline in the FTSE A50 index during the June-August 2015 period could have been viewed as an opportunity, the manic stabilisation efforts of the Chinese authorities acted as a deterrent for many investors.

“Recent data flows suggest it is time to take another look. There are still lots of new initiatives but policy makers do not seem so panicked. The market is up 13% since last year’s August low and has been making steady progress since the end of January. The easing by the People’s Bank of China has stimulated monetary growth, reduced bond yields and weakened the yuan, all of which should be supportive of local equities.”

From a valuation perspective, a cyclically adjusted price-to-earnings ratio of 9.1 is at a historic low, less than half the historical average of 20.3, and well below the current US multiple of 25. Furthermore, the emerging markets price-to-earnings average is around 12. Source believes these valuations justify a five year FTSE A50 target of 17,000, considerably above the current level of 9,723. Source calculations suggest a return potential of around 12% per year over the next five years (before allowing for dividends) – a generous risk premium versus other markets.

Jackson added: “The above calculations do not allow for what might happen when MSCI and other index providers include A-shares in their emerging market indices. This will likely happen this year or next. A mid-year dip in the Chinese market would not be unusual; however, we would use that as an opportunity to buy equities even more cheaply.”

The CSOP Source FTSE China A50 UCITS ETF (CHNA) trades on the London Stock Exchange in USD and GBP, on the SIX Swiss Exchange in USD, and on the Deutsche Borse and Borsa Italiana in EUR. The fund tracks the performance of the FTSE China A50 Index, representing the 50 largest A-Share companies listed on the Shanghai and Shenzhen Stock Exchanges. As of 27 April 2016 there is significant exposure to the financials (70.2%), industrials (11.1%) and consumer cyclical (5.3%) sectors. The ETF has a total expense ratio (TER) of 0.99%.

Investors willing to risk leveraged exposure to Chinese equities may wish to consider the ETFS 3x Daily Long FTSE China 50 (CH3L) which provides triple the daily performance of the FTSE China 50 Index. It has a 0.98% TER.

Other significant China-based funds include the iShares MSCI China ETF (MCHI) which has a TER of 0.62%, and the db x-trackers Harvest FTSE China A-H 50 Index UCITS ETF (AH50), designed to track the performance of the 50 largest China A-share companies while capturing any price differentials between dual-listed constituents’ mainland A-Shares and Hong Kong H-shares. TER 0.65%.

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