Liquidity flowing to China

Concerns about Chinese influence in politics and universities may be at fever pitch, but the reality is that some of Australia’s retirement savings will help fuel a predicted US$600 billion ($820 billion) inflow into mainland stocks over the next decade.

A-shares — stocks listed on mainland exchanges in Shanghai and Shenzhen — will now have a weighting of 12.1%. This is a substantial increase from the previous weighting of 7.9% in the MSCI China Index and 4.1% weighting in the MSCI Emerging Markets Index.

These MSCI China Index changes also see an extra 204 A-shares added to the list. This includes 22 companies from the tech-laden ChiNext market and brings the total number of A-shares included to 472.

HSBC estimates these changes could trigger US$5.5 billion worth of A-share buying over the next few weeks. That is US$5.5 billion that would otherwise have remained in markets outside of China.

And it does not stop there. Index compiler FTSE Russell will increase its A-share weighting to 25% in March 2020. This is up from the current 15% rating, and HSBC calculates this will send another US$4 billion into mainland stocks. Most of that will not be new money; it will be money diverted, or rebalanced, from existing holdings.

The changes force passive index-focused investors and funds to increase their weighting of Chinese stocks. Active investors outside of the fund management industry will have to consider both how much exposure they want to mainland stocks, and the impact on supporting liquidity for their existing index-linked holdings.

HSBC argues that “China is a market too big to ignore”. It estimates Chinese stocks could attract US$600 billion of foreign funds into China over the next five to 10 years. This puts China on the radar of some of the world’s smartest investors.

China has steadily transformed its financial markets over the past five years and continues along this path, particularly with support of a derivatives market that will hand investors better risk-management tools. The opening up of the Shanghai-Hong Kong and Shenzhen-Hong Kong stock connect programmes, as well as the Bond Connect, are all important parts of Beijing’s reform agenda aimed at deepening its capital markets and range of trading instruments available. China’s bond market is the world’s second largest and as capital account becomes more open, it will also become a magnet for foreign funds. First signs of this was the inclusion of Chinese bonds earlier this year in the Bloomberg Barclays Global Aggregate Index with a 6% weighting.

There is an estimated US$12.4 trillion of negative-yielding debt, so Chinese 10-year bonds with a yield of 3.18% look attractive. Capital will flow and this impacts on regional market liquidity and investment choices. Smart investors will go with the money flow.

Technical outlook for the Shanghai market
The Shanghai Index is struggling to stay around the 2,920 level. There is considerable bearish pressure with the index dropping towards 2,880 and then testing and retesting resistance near 2,920.

The index shows multiple bearish features, and these reduce the probability of a fast breakout above 2,930 or the development of a new uptrend. There are four main resistance features to be overcome before a new uptrend can develop.

The first feature is the strength of the support and resistance level near 2,920. The index must be able to move above this level and use it as a support level before any new uptrend can develop.

The second resistance feature is the relationships between the Guppy Multiple Moving Averages (GMMA). The short-term group of averages is below the long-term group of averages. This is a significant change in the GMMA relationships and shows that the bullish pressure in the market has disappeared. The upper edge of the short-term group is also below the resistance level near 2,920.

The long-term group of averages has compressed and turned down and are beginning to de- velop separation. This shows the beginning of a change in market sentiment, but it is not yet strongly bearish. In a strong bearish situation, the long-term GMMA would start to separate very quickly. The current relationship shows that bullish support for the market has disappeared. The market is cautious, but not yet strongly bearish.

The third resistance feature is the value of the down-sloping trend line. The three rally peaks starting from September act as anchor points for a downtrend line. The value of this downtrend line now acts as a resistance level for any rally above the 2,920 level. The current trend line value is near 2,975. A new sustained uptrend can only resume if the index is able to move above the value of the downtrend line.

The fourth resistance feature is the broader pattern of a down-sloping triangle that is created by the horizontal support line near 2,920 and the down sloping trend line. The combination of the downtrend line and the horizonal support level creates a down-sloping triangle pattern. This is not a well-defined pattern, so the pattern analysis conclusions are applied with caution. This chart pattern sets a downside target near 2,800. This is calculated by measuring the height of the base of the triangle and projecting this value downwards.

The 2,800 target level is below the value of the lower edge of the long-term support level near 2,830. This suggests that in any strong market fall, the Shanghai Index may dip to the 2,800 level before rebounding and developing a consolidation near 2,830.

These four features confirm a bearish market condition, but traders are ready to trade the impact of the revised MSCI China weightings.

Daryl Guppy is an international financial technical analysis expert and special consultant to AxiCorp. He has provided weekly Shanghai Index analysis for mainland Chinese media for more than a decade. Guppy appears regularly on CNBC Asia and is known as ‘The Chart Man’. He is a national board member of the Australia China Business Council