After flying under the radar for months while Chinese domestic markets continued to drift lower, rattled by trade war fears, a strengthening dollar and anxieties tied to the PBOC's deleveraging campaign, China's National Team made its presence felt several weeks ago, just as the domestic benchmarks broke below their 2016 lows, initiating a brief but intense buying spree that had a profound impact on global markets.
Since the August intervention, the actions of China's National Team elicited a 3% bounce in A-Shares. The intense media speculation that followed unsurprisingly caught the attention of analysts at Goldman Sachs (which has published several guides in recent weeks containing more of its patented "advice" on how clients should trade Chinese markets)
And in one of the most detailed reports on the subject to date, analysts at Goldman Sachs Portfolio Strategy Research group offered a detailed analysis of the National Team's tactics and financial heft. Among the report's most consequential claims is that the National Team's membership is even larger than the English-language press realizes: To wit, the Financial Times identified five funds back in May that had bought up billions of dollars in A-shares after the SSE bubble burst in 2015, and claimed that those funds had liquidated $28 billion in shares during the first quarter, representing the bulk of their assets.
However, according to Goldman's analysis, National Team membership (ie the number of Chinese banks and asset managers who take their marching orders directly from the CSRC) is much broader. By Goldman's count, more than 22 domestic funds have been documented doing the Communist Party's bidding. And as one would expect, their equity exposure has risen apace, and now amounts to 1.5 trillion RMB, or roughly $200 billion - equivalent to about 5.8% of the free float in the A-share market.
For our analytical purpose in this report, we define the Chinese 'National Team' as the entities that were either created during the 2015 market turmoil (with the objective of supporting the market, e.g. Central Huijin Asset Management) or those that already existed before the market crash but were actively engaged in the A-share market during volatile times (e.g. China Securities Finance). Our definition gives the 'National Team' an aggregated equity exposure of Rmb1.5tn (5.8%/2.9% of freefloat/listed A-share market cap), spread across 22 standalone entities as of 1H18.
Goldman breaks down the composition of the "National Team" as follows - pretty much everyone is in it:
Central Huijin and China Securities Finance are the two largest members of the NT. Goldman breaks down their holdings below, along with an analysis of the team's aggregate assets over time, which found that their holdings have been remarkably stable since they intervened to rescue the market in 2015:
Because Chinese regulators require A-share companies to report their top-10 shareholders every quarter, Goldman was able to create a detailed accounting of National Team ownership by company and sector. Unsurprisingly, Chinese banks and insurers were well-represented.
Sector-wise, banks and industrials represented 37% (Rmb0.5tn) of its outstanding equity exposures as of 2Q18, while Telecom and Real Estate only combined to 3.8% of the portfolio, translating into Rmb55bn. More importantly, from an allocation perspective, the 'National Team' is heavily overweight Banks, Energy, and Insurance, largely funded by its underweight positions in Staples and Tech, reflecting its overarching allocation bias towards 'Old China'.
By stocks, not surprisingly, large-cap banks and insurers were the top-dollar holdings, but the picture would look somewhat different from an ownership perspective (relative to the company's outstanding shares), with a few consumer and healthcare names showing up on the top-10 list.
In fact, the National Team is overweight these 'Old China' sectors, largely at the expense of consumer staples and tech (though a few big-name consumer and tech firms made the list):
Digging deeper into the details, Goldman also managed to create a detailed accounting of the National Team's purchases - though it's only able to measure the team's buying after the fact (with a two-month delay, to be specific). Though because disclosure rules only apply to a company's top ten shareholders, Goldman's measurements of the NT's buying are likely incomplete.
But even the incomplete figures are shocking: By Goldman's count, the National Team bought 116 billion RMB (roughly $17 billion) - equal to 02% of the free float of A-shares.
Reports in the domestic business press also offer a rough gauge of NT activity (after all, its existence is hardly a secret). However, these reports contain few details about who's doing the buying and - more importantly - what is being bought. While press mentions rose in July and August compared with H1, they were still far below levels from 2015 and 2016.
Like most investors, the National Team is looking to maximize the impact of each renminbi it spends. To accomplish this, buyers carrying out the will of the Communist Party typically focus on the SHCOMP's top 10 most heavily weighted constituents. That's because relative to Western markets, liquidity in these securities is comparably shallow...
The combination of strong focus from domestic investors on the Shanghai Composite Index (SHCOMP) and its index methodology (full market cap, non-freefloat adjusted) makes the index a prime target for receiving government support during stressed periods to support the market and boost sentiment. Specifically, the top-10 SHCOMP index constituents in total represent 28% of the index weight, but their average freefloat ratio is merely 26%. As such, intervening in these stocks (narrowing the bid-ask spread) could be a capital-effective way to support the market. Using this logic, and together with other pricing and turnover indicators (e.g. relative return and turnover velocity to the broader market), it appears to us that the National Team was heavily involved in A shares during the market sell-offs in mid-2015, and is turning active once again in recent months.
...As Goldman illustrates in the charts below:
There are three key markers of National Team activity: narrowing bid-ask spreads, rising turnover velocity and heightened return on the most heavily weighted companies vs. the broader SHCOMP index.
As regular readers will no doubt remember, we've long warned about the long-term risks of repressing the price-discovery process (and nationalizing capital markets). And as it happens, Goldman's research appears to bear this out. To wit, the National Team's interventions provide only short-term benefits (emphasis Goldman's).
- In a broader market context, meaningful buying from the National Team (notional size and/or % of freefloat shares) tended to precede short-term market/index recovery (+3m) but the subsequent 6- to 12-month returns post buying were mixed;
- At the stock level, concentrated flows (buy and sell) from the team usually led to strong 3-month absolute and relative returns, but the positive impacts usually faded after 3 months and normalized over the following 6-12 months;
- Importantly, while the ex-post returns of the team's long exposures were inconclusive (depending on the time horizons), the stocks that it sold/reduced have consistently generated negative absolute and relative returns, possibly reflecting its asymmetric 'signaling effect' to the market.
- For reference, we estimate that the weighted average cost (SHCOMP index level) of the team's long positions is around 3440, 21% above the current price.
Still, NT intervention has generally tended to generate positive three-month returns, which brings Goldman to the most important part of its note: How its clients/future bagholders should position themselves to maximize profits (in the short term, at least, until Goldman issues another note encouraging these same people to sell, sell sell). With the National Team's activity on the rise, Goldman is recommending that all clients buy A-share calls, ASAP.
- Call buying on A shares: Our analysis leads us to believe that the 'National Team' is stepping up its support to the market, which tends to drive short-term market recovery, or at least stabilization. This, together with our observations that micro fundamentals remain healthy, equity valuations are at multiyear lows, and local risk appetite is depressed on our measure, suggests a reasonable case for tactical market recovery in China A, in our view. That said, our near-term conviction is dampened by the ongoing Sino-US trade tensions, Rmb depreciation pressures, and EM volatility, which are clearly overarching macro issues that drive equity beta at the moment. As such, we see option strategies as a sensible way to express our constructive fundamental views on Chinese equities, especially considering the low implied volatility in A shares compared with historical norms and relative to realized vol. Call buyers risk losing their premium paid if the underlying closes below the strike price at expiration.
- GARPy 'foreign favorites': This remains our best thematic idea in A shares. In a nutshell, we believe its investment case is underpinned by: a) high and consistent fundamental growth which is currently priced at reasonable valuations (22% 2017-19 EPS CAGR, 18x fP/E, 1x fPEG); and, b) portfolio inflows are a scarcity in a weak market but the list has continued to receive strong Northbound flows (US$6bn ytd, US$3bn since June 2018) amid challenging market conditions, likely powered by index conclusions which could provoke long-lasting portfolio flows on our estimates.
- Follow the 'National Team': As shown in Section 4, the team's long positions tended to generate positive 3m returns while the stocks that saw sizable reduction from the team usually traded poorly in the subsequent 3-12 months. In this vein, we flag the noticeable changes in the National Team's aggregate portfolio during 2Q18, and observe that the team has net increased its exposures in GS-Buy rated names such as Industrial Bank, CMB, PingAn Insurance, CM Shekou, and Kweichow Moutai while Neutral rated names in the reduction category include Wuxi Little Swan.
Of course, there are plenty of reasons to remain bearish on Chinese stocks. As we pointed out on Saturday, China's trade surplus with the US hit a fresh record high at the worst possible time, virtually guaranteeing that the Trump Administration will continue to press ahead with its planned (and threatened tariffs), and that a much-hyped November meeting between US and Chinese officials will likely yield little, if any, progress.
Just something to keep in mind, dear reader, when the dominoes carefully laid by China's central planners (now market regulators) begin to fall as the strengthening dollar continues to seriously strain emerging markets.