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November 2017

The case for Chinese equities: Reform implications

Key points

  • We are overweight Chinese equities, expecting real GDP growth between 6 to 6.5% next year against a backdrop of strong corporate earnings growth.
  • Potential reforms are also a key driver: President Xi Jinping enters his second term well positioned to advance meaningful structural reforms following China’s 19th National Party Congress (NPC) held in October. We expect further specifics to follow in 2018.
  • Key initiatives discussed by Chinese policymakers include innovation, environmental protection, state-owned-enterprise (SOE) reforms, supply-side reforms and standards of living.
  • Although risks remain, solid growth in China may also continue to provide additional support to emerging market equities broadly.

Investors are beginning to pay attention

A steadier outlook for China provides a strong case not only for Chinese equities but is also a tailwind for emerging markets (EM) more broadly. Currently, China is 28% of the MSCI Emerging Markets Index, a figure which will rise to nearly 50% after the full inclusion of mainland Chinese equities into the index in a process that begins next year. China has contributed nearly half of the MSCI Emerging Markets Index’s 31% year-to-date total return and now accounts for 30% of the index’s forward earnings expectations.1 Positive inflows into China-focused exchange traded products (ETP) have helped drive broader EM inflows as well.2

Relative to market size, current inflows are smaller than compared to history

China inflows

Source: BlackRock, as of October 25, 2017. The lines represent the flow in to emerging market mutual funds and ETFs as a % of total AUM.

What to do now

Looking ahead, further details on China’s market-oriented reforms are likely to support investor conviction in Chinese equities as well as broader EM allocations. Within China, investors can consider broader MSCI China exposure or more precise large-cap exposure, which carries a larger sector weighting to technology that could benefit from potential new economy reforms. For broader emerging markets allocations, consider also adding a specific EM Asia tilt that benefits from China’s economic growth.

Earnings Momentum: Market turning more bullish

China earnings momentum

Source: I/B/E/S, Thomson Reuters, as of October 30, 2017. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Christopher Dhanraj
Head of ETF Investment Strategy