The inclusion of Chinese A-Shares into the MSCI Emerging Markets Index at the beginning of June was intended to introduce Chinese companies with attractive valuations into the marketplace, but its impact has been lost in the crossfire of trade concerns with the United States.
In the beginning of June, 234 Chinese companies were introduced into the MSCI Emerging Index, which would include A-shares–a mix of Chinese companies with a penchant for strong earnings per share growth potential. Analysts debated the impact this would have, but most would agree that it would introduce diversification into the emerging markets and investor ingress into this once hard-to-access marketplace would be easier.
Unfortunately, just a couple of weeks after its inclusion, U.S. President Donald Trump fired the first salvo of tariffs directed at China after months of dropping hints that China was engaging in unfair trading practices–a 25 percent tariff on up to $50 billion in Chinese goods “that contain industrially significant technologies.” The Chinese Commerce Ministry counterpunched with a 25 percent tariff on $34 billion worth of U.S. goods.
The tariff-for-tariff tussle continued when the Trump Administration threatened to impose an additional round of tariffs on another $200 billion worth of Chinese goods was proposed “if China refuses to change its practices, and also if it insists on going forward with the new tariffs that it has recently announced.” The effect of these trade spats have been giving the Dow Jones Industrial Average gut shots in the month of June, including an eight-session losing streak.
Likewise, the trade spats have done no favors to the Chinese markets as the Shanghai Composite Index fell 0.97 percent recently, reaching a 52-week low. The Shanghai Composite Index chart for the month of June looks similar to the Dow with its downward trajectory.
China-focused ETFs have also taken a brunt of the punishment with iShares China Large-Cap ETF (NYSEArca: FXI) and iShares MSCI China ETF (NASDAQ: MCHI) both down about 9 percent for the month. In terms of the broader impact on emerging markets, the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) is down about 8.3 percent heading towards the end of a raucous June.
The back-and-forth between the United States and China has largely muffled the noise surrounding the inclusion of China’s A-shares into the emerging markets space.
“Unfortunately we think the announcement, and the positive sentiment that ought to have surrounded it, has been drowned out by the talk of trade wars and tariffs which seem to be dominating markets right now, particularly the Chinese market,” said Rob Bush, ETF Strategist at DWS.
Still Room to Grow
Despite the trade concerns, opportunities in Chinese markets can still be had. Per Reuters, the second largest economy in the world is “trying to walk a tightrope between supporting economic growth and tamping down financial risks, with policymakers freeing up more funds for lending by cutting required reserve levels for banks twice since April.”
That said, the impact of the A-shares inclusion is still too soon to determine.
“In the long term the direction of travel has been signaled in our view – the onshore Chinese market is becoming more accessible, more important, and will continue to play an increasing role in international benchmarks, indexes, and portfolios,” said Bush. “The Chinese stock market is the second biggest in the world after the US, and we believe it will continue to grow.”
The bigger question lies in whether the markets can shake off these looming trade concerns.
The introduction of A-Shares in June will continue its two-step process into the MSCI indexes with another set of inclusions set to occur in September. As such, capital inflows into these A-shares should go undeterred despite the fluctuations instigated by the trade concerns.
“To an extent it has to (positively impact flows) because, as greater clips of the Chinese market are included in key benchmarks, investors that track those indexes will need to buy China A-shares to get up to the appropriate weighting,” said Bush. “That said, we do think this will be quite a gradual process.”
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