China ETFs in Focus on Surprise Rate Cut
The People's Bank of China (:PBOC) surprised the global market on Friday with a cut in interest rate for the first time in more than two years in an effort to boost its slumping economy. The central bank slashed the one-year lending rate by 40 bps to 5.6% and the deposit rate by 25 bps to 2.75%.
Additionally, the PBOC gave Chinese banks more flexibility in setting the interest rates on deposits as the ceiling has risen from 1.1 times to 1.2 times. China has with this unexpected stimulus joined a band of countries which are stepping up their efforts to support the economy. The European Central Bank and Bank of Japan have deployed stimulus plans to revive growth in their regions. These are in contrast to the U.S., which has stopped its monetary expansion plan (read: Japan Hedged ETFs in Focus after BOJ Action).
The move came amid a slew of disappointing economic data in recent weeks. Chinese economic woes deepened further in October with factory growth slowing down to the second weakest pace since the global crisis and investment growth hitting an almost 13-year low. Retail sales grew just 11.5%, representing the slowest growth since early 2006 while inflation dropped to a five-year low.
Bad loans surged to the highest level since 2008 triggered by declining property prices and an economic slowdown. Adding to the concerns, China’s economic growth slowed to a more than five-year low of 7.3% in the third quarter. All these negative feelers point to the fact that China is headed for its worst growth since 1990 and is in dire need of a stimulus.
The interest rate cut was further influenced by the lackluster launch of Shanghai-Hong Kong Stock Connect program last week. This trade link allows direct trading of Shanghai shares by investors outside mainland China for the first time (read: China A-Shares ETFs Soar on Cross-Border Trading Link).
Market Impact
The sudden move by the People’s Bank of China, which signals the beginning of a loose policy era, spurred a rally in the stocks around the world. In particular, Chinese stocks in Hong Kong as depicted by Hong Kong’s Hang Seng China Enterprises Index climbed 3.5%, marking the biggest one-day gain in almost a year. Meanwhile, the Shanghai Composite Index rallied 2% and the 10-year bond yield saw the largest one-day drop since 2008.
The smooth trading in stocks also sparked a rally in China ETFs. China A-Shares ETFs were the biggest beneficiaries with Deutsche X-trackers Harvest CSI 300 China A-Shares Fund (ASHR) climbing the most – over 5% on the day – followed by 4.8% gains for PowerShares China A-Share Portfolio (CHNA). Other China A-Shares ETFs like Market Vectors China ETF (PEK), db X-trackers Harvest MSCI All China Equity Fund (CN) and KraneShares Bosera MSCI China A Share ETF (KBA) are all up over 4%.
Apart from these, the most popular large cap focused funds – iShares FTSE China 25 Index Fund (FXI), iShares MSCI China Index Fund (MCHI) and SPDR S&P China ETF (GXC) – rose about 3.5% while the ETF targeting the financial sector Global X China Financials ETF (CHIX) was up about 4% (see: all the emerging Asia Pacific ETFs here).
Interest Rate Cut: A Boon or Bane?
Effectively, the action will lift the country’s dwindling housing market and improve the overall condition of the financial sector, which is currently facing headwinds from rising bad loans and a slowdown in profit growth. This is especially true, as the rate cut would reduce corporate debt burdens and the chances of default on bad loans while strengthening the borrowers’ balance sheet.
As such, financing costs for borrowers will decline allowing companies to access cheaper credit easily. In particular, China's state-controlled companies involved in large projects overseen by the government will gain the most from this action. The PBOC move will not only boost investments in the country but would also bolster the economic position of other countries relying heavily on the Chinese economy (read: Should You Buy China ETFs on Stimulus Bet?).
Just as the cheap credit is likely to fuel growth in the world’s second-largest economy, it could inflate corporate and local government debt. Further, it would narrow the spread between lending and deposit rates, thereby eating into the profit margin of the banks and hurting their profitability. This would in turn make it tougher for lenders to maintain their capital requirements.
To sum up, the interest rate cut is clearly good news for the broad Chinese economy and will speed up growth and business activities. However, the sentiment for the banks is somewhat mixed – bolstering the health of their balance sheet on the one hand while hurting bank profit margins on the other. Investors should therefore take a closer look at the Chinese ETFs that are in focus in the coming weeks.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report >>
Read the analyst report on ASHR
Read the analyst report on CHNA
Read the analyst report on PEK
Read the analyst report on CN
Read the analyst report on KBA
Read the analyst report on FXI
Read the analyst report on MCHI
Read the analyst report on GXC
Read the analyst report on CHIX
Zacks Investment Research
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
