China's Market Rally: A Genuine Upturn?
Goldman Sachs' Flow Expert Affirms the Authenticity of China's Market Surge
On January 24th, we advised our Premium-Subscriber Twitter followers to invest in FXI. Like most of our exclusive recommendations, this one has proven successful.
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However, after a 30% gain, the question arises - should we continue with this trade? Goldman Sachs' flow of funds expert addresses this question today, asking and answering, "Is This China Rally for Real?"
His response is straightforward:
"Yes. TCT (The China Trade) is back."
Observations on China's Market Activity
This week, we've observed the highest level of activity in China's market for 2024, with a diverse range of investors participating. This seems to be more than just short covering, as there are signs of growth. We've noticed a significant demand from Long Only investors, which is a new development. I'll be dedicating time to this over the weekend to share a more comprehensive trade thesis.
China's equity market is experiencing a high-volume breakout, even when the southbound connect is on holiday. The reasons? Anticipated catalysts in the upcoming weeks and months, including the long-awaited Third Plenum and more specific policies related to the overall guidance of the Nine measures.
Checklist for TCT: Catalysts, Flows, and Macro Ideas
Potential Catalysts to Shift Negative Expectations
GS Research has identified several potential catalysts that could potentially alter the entrenched negative expectation and sentiment:
1. A comprehensive and forceful easing package
2. Stimulus focused on demand-side
3. Policy aimed at boosting confidence in the private economy
4. Government support in the housing and stock markets
5. Improvements and predictability in US-China relations
The New "Nine Measures"
GS Research analyzes the potential policy-driven upside through the lens of shareholder returns, corporate governance standards, and institutional investor ownership. Their analysis suggests that A-shares could increase by approximately 20% if they could narrow the gaps with international averages along these dimensions, and could re-rate as much as 40% if they catch up with global leaders in our blue-sky scenario.
Current Positioning and Rising FOMO
1. Hedge Fund Positioning:
a. Both Gross and Net allocations to China increased in April, but continue to stay close to 5-year lows.
b. The 5 year low of gross exposure was 4.7% on March 27th and low net exposure in January of 6.2%.
c. Chinese equities were moderately net bought (+0.5 SD) in April and are now net bought in four of the past five months.
d. Chinese domiciled equities (onshore and offshore combined) were net bought with long buys exceeding short covers in a ratio of 5 to 1.
2. Global Mutual Funds (as of Mar-end):
Based on EPFR data, mutual funds globally in aggregate have 5.2% allocation in Chinese equities as of end-March, which represents 1st percentile over the past decade.
3. Southbound/Northbound Trading Flows:
A-shares have seen US$10.3bn Northbound inflows ytd, surpassing the US$8.1bn for full-year 2023. Southbound saw strong buying of US$27bn ytd.
4. Options - During NYC Macro trading, we are seeing hedge fund buyers of call options and ETF’s. We’re now witnessing a strong chase for HK/China upside (outsized call option volumes yesterday in both FXI and KWEB).
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Final Thoughts
The recent surge in China's market has sparked a flurry of activity and interest. But is this rally a genuine upturn or just a temporary spike? According to Goldman Sachs' flow expert, the answer is a resounding yes. But what do you think? Is this China rally for real? Share your thoughts and this article with your friends. Don't forget to sign up for the Daily Briefing, delivered to your inbox every day at 6pm.
