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China Backdrop: Fundamentally and Technically Positive

July 16, 2019 | Global/Emerging Markets

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China's official launch of a technology innovation board on the Shanghai Stock Exchange, STAR Market, which is sometimes referred to as China's Nasdaq, may support the Chinese equity market in the near term with incrementally positive inflows, especially into the quality growth companies to which we are particularly attracted.

But that's not the only good news coming from China right now: a recent research trip to China convinced me that the fundamental and technical backdrop for Chinese stock performance remains relatively favorable for the rest of 2019.

Overall sentiment (both business and investor) has continued to improve since my last visit in March, as reflected in the strong year-to-date rally of the China A-shares market.

The improved sentiment has been driven primarily by increased expectations for government support of the economy.

Despite the improved near-term sentiment in China, most people I met with during my research trip believe downward pressure on the overall economy remains.

Expectations for government economic support are broadening to include monetary policy, with interest-rate cuts and loosening of property-market control possible this year. Although both measures could add further stress to the structural issues China is already facing if the magnitude is large, the near-term implications to the market could be material to the upside. So the situation bears close watching.

Despite the improved sentiment, most people I met with during the trip believe downward pressure on the overall economy remains.

While the government support should have positive effects in the short term, it may not alter the decelerating medium-term economic cycle China is facing. This is not surprising given the current rebalancing and ongoing structural reforms.

In addition, U.S.-China relations may experience additional setbacks and volatility given the United States' unchanged view of China as a threat.

Therefore, I believe high-quality companies with market leadership and structural growth opportunities should remain the focus of our investments.

That said, earnings growth should start to improve from the third quarter onward, as companies benefit from China's supportive policies. This should provide fundamental support to the market.

From a technical perspective, there are concerns about near-term market consolidation after a strong run-up year-to-date, but at least two factors are supporting positive inflows.

First, as my colleague Romina Graiver discussed in another post, MSCI and FTSE Russell are increasing the inclusion of China A-shares in key indices, sending an unequivocal message about the index providers' (and institutional investors') confidence in China. This enhances opportunities for skilled managers to add value given the less efficient nature of the Chinese domestic markets.

Second, the launch and continued development of the Shanghai Stock Exchange’s new technology board could, as I noted, support the market, particularly in regard to technology related names.

This should encourage investment in domestic technology companies, thereby, ensuring they have resources to develop their products and services, and also have an incentive to list in their home market. And that is a boon to investors in China A-shares.

Vivian Lin Thurston, CFA, partner, is a portfolio manager and research analyst on William Blair's Global Equity team.

Past performance does not guarantee future results. Any investment or strategy mentioned herein may not be suitable for every investor. Investing involves risks, including the possible loss or principal. Equity securities may decline in value due to both real and perceived general market, economic, and industry conditions. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. The securities of Chinese companies may be subject to greater volatility and less liquidity than companies in more developed markets.