In the event of the Fed staying dovish and/or the RMB depreciating further against the USD, Goldman Sachs analysts anticipate that macro flows would stay equity-friendly in the near term. Si Fu and team point out in their August 24 research piece titled “China Musings: The war of liquidity: Who wins, and how to engage?” that MXCN is trading at around mid-cycle levels, and even higher excluding banks.

MSCI China rallied 12% since Brexit vote

Fu and colleagues note that even though the MSCI China has rallied 12% on a YTD basis since the Brexit vote, China remains a laggard versus EM and APJ. The analysts break the flows into three major components: (a) Passive ETFs across mandates, (b) Active funds and (c) Southbound Connect flows. The GS analysts highlight around $10 billion of inflows into HK/China YTD, led by Southbound and Connect buying ($14 billion), and ETFs ($6 billion, largely from EM), offsetting the continued outflows for active mandates ($10 billion).

China, Macro Flows Strong ETF flows

The analysts point out that despite the strong inflows exhibited by ETFs and Southbound Connect, active funds have clocked 13 consecutive months of outflows since July 2015. However, the analysts note that EM active funds have witnessed modest inflows since the Brexit vote.

Earlier, ValueWalk highlighted that nearly $500 billion left China between October 2015 and June 2016. It is felt that the money drainage is starting to be a big problem for Beijing, particularly due to weak international trade.

GS stays Marketweight on China

After investigating the drivers of flows to HK/China, Fu and team highlighted that flows are not equal. They point out that passive inflows to EM have been well-correlated with low bond yields globally, exemplifying the search for yield and positive carry in EM. The analysts believe the weakness of the RMB could be a possible reason for Southbound buying. The analysts believe active flows appear better linked with China fundamentals, with outflows moving in tandem with the slowing China growth momentum:

Flows are not equal

From a forward-looking basis, the GS analysts believe global and China Southbound flows may stay equity-bullish in the near term if the Fed continues to stay dovish and/or the RMB continues to weaken against the USD. However, the analysts would remain cautious on the idea of turning positive on the market in a wholesale manner, considering that macro fundamental and earnings outlooks are likely to stay subdued in the near term.

While staying Marketweight on China, the GS analysts advocate a more specific approach for active investors to hedge against the risk of liquidity overshoot, with a focus on index heavyweights, quality laggards, and select HK equities:

GS favors index heavyweights