Shanghai Composite Index Gains as PBOC Injects Liquidity

The Shanghai Composite Index rose 21.21 points on Monday, or 0.68 percent, to end the day at a final closing figure of 3,144.37. The Index has recovered 2.23 percent over the last month, and has struggled back to a 1.31 percent return since the beginning of the year, though it’s down 3.27 percent from where it was three months ago. Over the last twelve months, the Shanghai Composite has gained investors 8.85 percent. The ChiNext, an index of smaller firms, was up 0.4 percent today.

Overall, it was a positive day for Asian stocks. The Nikkei gained 0.62 percent for the day, pushing the Japanese benchmark over 20,000 points thanks to a weakening yen boosting exports. Australian shares, represented by the S&P/ASX 200, gained 0.5 percent, and Hong Kong’s Hang Seng bourse was up 1.16 percent. The Kospi showed a gain of 0.38 percent. The Shenzhen index gained 0.58 percent today.

Chinese stocks benefitted from further liquidity injected into the market thanks to the People’s Bank of China, which pumped 110 billion yuan US$16.2 billion into the market today in open market operations. Monday was the second straight trading day the PBOC pushed more liquidity into the market – they created 250 billion yuan in liquidity on Friday to slosh around markets. Friday’s injection of cash into the financial system was the single largest open market operation since January. Analysts chalk up the big infusion of fresh cash to a routine operation to offset a seasonal credit squeeze thanks to corporate tax payments coming due.

Friday’s central bank largesse was not enough to keep markets in positive territory for that day, however. Friday saw the Shanghai Composite lose 0.3 percent while the Shenzhen Composite fell 0.2 percent.

Bank stocks suffered the most last week, falling by 1.38 percent overall.

Meanwhile, the U.S. Federal Reserve increased interest rates by 0.25 percent for the 2nd time in three months. Most analysts project at least one more rate hike from the Fed before the year is out.

Politics & Policy

The top Chinese securities regulator is cracking down on illegal stock market activity, handing out more fines over the first five month of the year than in all of 2016. Total fines this year total about 6.14 billion yuan, or $901 million. The 2016 total amount of fines imposed was up 288 percent compared to 2015. The China Securities Regulatory Reform Commission has been toughening enforcement since the 2015 market crash in an effort to boost consumer confidence in the stock market.

China has removed a series of restrictions on its 11 free trade zones, slashing by 27 the number of restrictions imposed on eight different industries. Officials relaxed rules restricting foreign companies from manufacturing electric cars. Foreign banks are now allowed to underwrite Chinese government bonds. The number of restrictions on foreign companies operating in China’s free trade zones was 190 in 2013. It has gradually been lowered to 95.

China has been working to convince MSCI to include Chinese equities in its popular emerging markets index product – a move which would likely bring in hundreds of billions of dollars in investment into Chinese markets. MSCI has cited the lack of openness of Chinese markets in the past as one of its reasons for not accepting China into the index.

China is investing some US$411 billion yuan into building out 5G mobile networks throughout the country over the next 13 years. The move would likely boost demand for cell phones and mobile devices. Total 5G subscribers on the mainland are forecast to reach 588.3 million by 2022, up from 31.9 million in 2019, according to Jefferies’ Lee.

China’s Economy

Foreign direct investment in Mainland China fell 3.7 percent in May on a year-over-year basis, per Ministry of Commerce Data. Foreign Direct Investment was lower in April as well, falling by 4.3 percent on a year-over-year basis. In March the FDI number was much higher, risking 6.7 percent compared with the previous March levels.

However, foreign direct investment in the Chinese service sector continues to expand rapidly, with 48.64 billion yuan of foreign capital – an increase of 20.5 percent year over year, per Ministry of Commerce numbers. Foreign direct investment in communication equipment manufacturing skyrocketed 46.6 percent over the five-month period ending in May.

The service sector’s added value accounted for 51.6 percent of China’s GDP in 2016 – below the average 57 percent level among middle-income economies, according to the National Development and Reform Commission, China’s top economic planning body.

Analysts are predicting the People’s Bank of China may act to increase interest rates on mortgages soon. That move could throw a wet blanket on Chinese property developers and homebuilders as higher interest rates quash mortgage demand and with it, demand for property. We have been seeing an overall cooling in property markets in many Chinese cities.

Chinese Economic Outlook

Tuesday night Eastern Time is Judgment Day for Chinese traders hoping for MSCI to approve including Chinese equities in their emerging market Index. The company is scheduled to make their decision after trading hours tomorrow night. The likelihood is that MSCI will give the green light this year.

It won’t be a miracle, though: In the event of approval, actual capital flow into the Chinese market as a result will be very limited, since Chinese stocks would only have an initial weighting of around 5 percent. If you do get a big bump after an approval, it may be time to take some money off the table shortly afterward.

Donald is a strategist for economiccalendar.com. He specializes in a fundamental approach while informing traders of relevant economic data. Actively trading since university, Donald trades indices and commodities. He earned his Bachelor's in Finance from Baruch College's Zicklin School of Business in New York City.