As money pours in, can Chinese markets continue the upward trend, or is it too much too soon?
- With China’s foreign exchange reserves beating expectations, A-shares erasing 2018 losses and new recognition from international benchmarks, investors have reason to smile
Chinese equities started April 2019 at almost exactly the same level as they began April 2018. The renminbi’s sharp rebound from the end of last year looks likely to continue. And Chinese bonds appear unlikely to top a stellar 2018. While all three of these assets demonstrate wildly different fundamentals and the outlook appears markedly different on each, it is clear that investors are broadly optimistic about China in 2019. How do I know? Recent reserves data clearly shows increasing investor purchases of Chinese assets.
Capital flows can be some of the most revealing data for understanding global markets. The amount of money flowing into a country, and therefore purchasing assets denominated in the local currency, versus money-seeking investment opportunities elsewhere, plays an important role in setting the exchange rate. It also gauges how attractive a particular market is in relation to the rest of the world.
Money used for investment in financial and real assets or business operations and development that moves between countries is classified as capital flows. Because movement of this money often requires exchange into different currencies, a country’s central bank will maintain a stock of foreign currency, or foreign exchange (FX) reserves. When capital inflows increase, FX reserves increase and vice versa. It should be noted that countries also maintain FX reserves to shield against turbulence in their markets and give investors’ confidence a government can pay its bills in the event of a sharp devaluation of their currencies.
Capital flows, though invaluable information, are often reported with a significant lag. Tallying up all the different types of investment and tracking the different channels through which money enters a country can take a lot of time. Therefore, FX reserves data is often used as a more readily available indicator of a country’s capital flow picture, and thus how relatively attractive assets in that market are.
Therefore, it should not surprise anyone that better-than-expected FX reserves for China in March produced a new round of optimism for Chinese assets. Reserves increased by US$9 billion, while consensus expectations were for an increase of US$5 billion, bringing China’s stock to US$3.099 trillion. Interest begets interest and more money pouring into China’s markets increases confidence that prices will rise in the near future.
Yields on Chinese government bonds, the largest part of the onshore bond market, have actually risen this year in most maturities (bonds yields move inversely to prices). However, the inclusion of Chinese bonds into global benchmarks could prompt a rally in the remainder of the year as global investors raise their allocations.
These shifts in the fundamentals should support a rally in risk assets, but markets have run further than fundamentals would suggest. The strong demand evidenced in the FX reserves data explains part of the reason why – prices tend to rise when demand rises. Whether this continues throughout the year to truly make 2019 the opposite of 2018 remains to be seen, but the demand side of the equation seems to suggest markets are at least supported at current levels.
Hannah Anderson is a global market strategist at JP Morgan Asset Management
