Chinese financial markets just went global and that could be bad news for Australian stocks

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It was a historic day for Chinese financial markets yesterday with the nation’s mainland-listed stocks gaining admission to the MSCI’s indices after three unsuccessful attempts, paving the way for increased foreign investment in the years ahead.

To Hasan Tevfik and Peter Liu, research analysts at Credit Suisse, while the MSCI decision is largely symbolic at this stage, with only a tiny amount of Chinese A shares being admitted to the group’s indices, over the longer-term it will have large-scale implications for global fund flows as China’s market weighting grows.

And that presents a risk for Australia’s stock market, particularly for large cap stocks.

“At $US34 billion the A-shares inclusion will initially not be a big deal for investors in Australia or elsewhere for that matter,” the pair wrote in a note released on Thursday.

“For example, the A-share weight in the MSCI Asia Pacific ex Japan index will be 0.68%. Australia currently has a weight in this index of 18.9% and all other things equal, this should fall to 18.8% after A-shares’ inclusion, so there will be very little initial impact on demand for Aussie equities.

“However, we expect the weight of A-shares in regional indices to grow and eventually dwarf Australia as the centre of gravity of regional equity markets continues to migrate north.”

This chart from Tevfik and Liu shows individual country weights in FTSE/Datastream Asia ex Japan Index, a rival to the MSCI, along with their forecast for weightings out to 2030.

China’s weighting look set to grow substantially, in their opinion, while Australia’s will shrink.

Source: Credit Suisse

“At this time we assume Chinese stocks, A-shares and H-shares, will account for 30% of the regional index, a rise of 22 percentage points,” the pair wrote.

“Australia will account for just 6%, a fall of 6 percentage points.

“There has been a giant living on our street and it is just about to come out to play.”

And that giant, China, could present a downside risk to Australia’s stock market, says Tevfik and Liu, particularly with the increased involvement of passive funds within the Australian market.

“We think the losers in Australia during this migration will be those stocks where passive funds are bigger holders,” they wrote.

“As the boffins at the index providers raise the weight of China, and by default lower the weight of Australia, global passive funds will be obliged to slavishly follow their masters.

“They will be net sellers of Australia and net buyers of China.”

And, as shown in this chart from Credit Suisse, most of these passive funds — exchange-traded funds (ETFs) — are heavily invested in Australia’s largest stocks.

Source: Credit Suisse

Tevfik and Liu suggests that if there are to be losers from China’s mainland-listed stocks being admitted to the MSCI indices, it’s likely to be hardest felt in Australia’s largest stocks.

“The relative losers will be the larger Aussie stocks, in our view,” they wrote.

“These companies have the highest proportion of passive-index focused investors on their registry and these are the stocks that are likely to see the most selling as the global and regional passive funds re-allocate to the A-Shares.”

Given current market capitalisation, that means the banks, major miners, Telstra and the likes of Woolworths and Westfarmers, among others.

However, while they’re likely to be the losers in Tevfik and Liu’s opinion, that suggests Australian-listed global financial firms — such as Macquarie Bank and Computershare — will benefit from continued capital market reforms in China.

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