Since peak post-COVID reopening optimism in early 2023, Chinese equities lost over a third of their value, as investors digested worries around a worsening real estate downturn, persistent geopolitical risks and issues around longer-term growth prospects. Zooming out further, Chinese equities are down over 50% since their 2021 high. Recent rumors and headlines around potentially more substantive policy easing in the property sector, capital market support measures and technical dynamics, have coincided with a sharp rebound since mid-January this year. This has propelled the offshore MSCI China over 20% and the onshore CSI300 over 15%, outperforming regional markets like Japan and India – making the Chinese market among the best performers in the world over this time. This surge has captured the attention of global investors, with many wondering if they should “chase this rally”.
In this edition of Asia Strategy Focus we zoom in on exactly what factors are driving this rally, assess whether it can continue, and consider the upcoming policy catalysts that could move the market.
Chase the rally?
To understand whether the rally is sustainable (and worth chasing), one needs to know what has underpinned the market. Is it driven by fundamental factors such as growth and earnings upgrades? Are stable “long-only” equity funds increasing their allocations? Or has it been driven by retail investors chasing low valuations (or something else entirely)? The former would speak to this rally having further legs, while the latter might give pause.
Who is driving this rally?
1. Is it global fund managers “closing their short positions?”
There has been a lot of reporting on global fund managers “closing their short positions” by increasing their China exposure within actively managed equity funds, particularly those focused on Asia or emerging markets (EM).
However, the data is showing something different. While there is no comprehensive data on positioning, comparing China allocations in actively managed EM funds relative to passive EM exchange traded funds (ETFs) that follow the benchmark can give a sense of how global portfolio managers are positioned. Using this proxy, portfolio managers are indeed underweight. While they have slightly reduced the size of the underweight, it remains near multi-year lows. There has been no dramatic shift in fund manager positioning like what was seen in past market upturns in 2014 and 2017.
2. Are global investors finally turning more positive on China?
Beyond fund managers, has there been substantial flows from other global investors into Chinese equity funds and ETFs? Is changing global sentiment and the overall increase in money invested in offshore equities behind the rally? This is relevant in the context of Japan and India, which have seen some recent inflows coinciding with China outflows. Are these starting to reverse?