Chief economist update: China's neo-great leap forward

Quitaly and Spanish Prime Minister Mariano Rajoy's exit and the curious case of the US-North Korea summit have drowned China's modern version of the "Great Leap Forward".

The first day of June marked when MSCI included Chinese A-shares into its benchmark MSCI Emerging Markets Index, MSCI All Country World Index and MSCI China Index - a culmination and fulfilment of MSCI's announcement made one year before.

According to Reuters, the 234 China A-share companies have a combined market capitalisation of $21.969 billion. They will represent aggregate weights of 1.26% in the MSCI China Index and 0.39% in the MSCI Emerging Markets Index at a 2.5% foreign index inclusion factor (IIF). China's A-shares will then rise to a weighting of around 0.8% in the MSCI Emerging Markets Index by September this year - after MSCI's August rebalancing and increase the IIF to 5%.

But while the event was momentous, a Great Leap Forward it was not for the Chinese stockmarket. The SSE A-share index fell 0.7% on the day of China's inclusion in the MSCI, it was down 2.1% on the week, up 0.4% in the month of May and 7% lower since the start of 2018.

Why? China A-shares inclusion into the benchmark MSCI indices is a sure-fire way to get money flowing into China's stockmarket. Indexed funds, Exchange Traded Funds (ETFs) and active funds, among others, benchmarked against the MSCI would need to buy Chinese shares in order to track their performance against well...the MSCI benchmark.

This could be because of the nagging uncertainty over its trade spat with the US and concerns over the US-North Korea summit or the spill-over from the general equity market anxiety that has befallen most global financial markets in the second half of May or its ballooning debt, or selling on news.

It could be all of the above, including selling on news. According to the Australian Financial Review (AFR) " the weeks before the MSCI China A-share inclusion, buying accelerated, with April recording a high monthly northbound net inflow of 40.54 yuan, up 222% on March's northbound inflow and a staggering four times the net inflows seen in April 2017."

But while funds would continue to flow into China's equity market - mainly for institutions to meet their benchmark allocations - the ultimate test would be the emergence of another market rout such as the experience of years gone by where Chinese regulators implemented trading halts, restrictions against stock sell orders and according to Bloomberg,

"Individuals and day traders make up about 80% of the trading volume. Fueling the bubble and collapse in China's equities three years ago were millions of new investors, some of whom had never attended or graduated from high school."

Ben Ong is the Director of Economics and Investments at Rainmaker Group. He previously worked as a fund manager, economist, asset allocation strategist, portfolio analyst and stock market analyst. Check out his economics analysis here.

Read more: Markets IndexGreat Leap ForwardMSCI China IndexKoreaMSCI All Country World IndexMorgan Stanley Capital IndexReutersAustralian Financial ReviewBloombergExchange Traded Fundsneo-Great Leap ForwardQuitalySpanish Prime Minister Mariano RajoyUnited States
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