As money pours in, can Chinese markets continue the upward trend, or is it too much too soon?

With China’s foreign exchange reserves beating expectations, A-shares erasing 2018 losses and new recognition from international benchmarks, investors have reason to smile

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An investor at a stock exchange in Nanjing on March 4, as Chinese shares closed higher following the MSCI's decision to increase the weight of China A-shares in its indexes. Photo: Xinhua

Published: 11:00am, 12 Apr 2019Updated: 10:24pm, 12 Apr 2019

Chinese equities started April 2019 at almost exactly the same level as they began April 2018. The renminbi’s sharp rebound from the end of last year looks likely to continue. And Chinese bonds appear unlikely to top a stellar 2018. While all three of these assets demonstrate wildly different fundamentals and the outlook appears markedly different on each, it is clear that investors are broadly optimistic about China in 2019. How do I know? Recent reserves data clearly shows increasing investor purchases of Chinese assets.

Capital flows can be some of the most revealing data for understanding global markets. The amount of money flowing into a country, and therefore purchasing assets denominated in the local currency, versus money-seeking investment opportunities elsewhere, plays an important role in setting the exchange rate. It also gauges how attractive a particular market is in relation to the rest of the world.

Money used for investment in financial and real assets or business operations and development that moves between countries is classified as capital flows. Because movement of this money often requires exchange into different currencies, a country’s central bank will maintain a stock of foreign currency, or foreign exchange (FX) reserves. When capital inflows increase, FX reserves increase and vice versa. It should be noted that countries also maintain FX reserves to shield against turbulence in their markets and give investors’ confidence a government can pay its bills in the event of a sharp devaluation of their currencies.

Capital flows, though invaluable information, are often reported with a significant lag. Tallying up all the different types of investment and tracking the different channels through which money enters a country can take a lot of time. Therefore, FX reserves data is often used as a more readily available indicator of a country’s capital flow picture, and thus how relatively attractive assets in that market are.

Therefore, it should not surprise anyone that better-than-expected FX reserves for China in March produced a new round of optimism for Chinese assets. Reserves increased by US$9 billion, while consensus expectations were for an increase of US$5 billion, bringing China’s stock to US$3.099 trillion. Interest begets interest and more money pouring into China’s markets increases confidence that prices will rise in the near future.

Indeed, so far, 2019 is looking like a mirror image of 2018. After being down 32 per cent from the year’s prior high at one point in 2018, A-shares have rebounded in 2019 to almost erase all of last year’s losses. Chinese bonds rallied throughout 2018, as fixed income often does in times of equity market turbulence, returning 8 per cent to investors in the broad onshore benchmark.