Global Equity Strategy

Weekly discussion of recent equity market action with equity sector highlights and what it may mean for investors.

November 29, 2016

Sean Lynch, CFA, Co-Head of Global Equity Strategy

A Busy Week Ahead for Chinese Equities

  • The week ahead features several important developments for Chinese equity markets. The launch of the Shenzhen-Hong Kong Stock Connect program will expand access to Chinese equity markets. Further, manufacturing data to be released on Thursday will offer perspective on the Chinese economy.
  • Increased investor access to Chinese equity markets offers both opportunities and challenges. The Shenzhen market has many technology stocks that represent the “new China.” Yet, these markets can be volatile. Additionally, worries over potential future strains in U.S.-China trade relationships have some investors questioning investments in China.

What it may mean for investors

  • We hold a favorable view on Emerging Asia equity markets, and believe that they are most positively positioned within the emerging-market equity group. While China is the largest weight in emerging equity-market indices, diversification and selectivity remain important in this asset group.
speedometer reading of equities: large cap, mid cap, developed markets, small cap, and emerging-market.

China’s equity markets will have plenty of information to digest this week. Chinese equity investors already are dealing with a currency (the yuan) that has declined steadily since the U.S. election and a sell-off in emerging-market stocks over the past month. This week, two positive items that bear watching are: 1) the opening of the Shenzhen stock exchange to Hong Kong investors on December 5, (which was widely expected but formally announced last Friday) and 2) Chinese economic data, especially the manufacturing purchasing managers’ index (PMI) data expected this Thursday. In this week’s report, we discuss how investors may respond to the expanded access to Chinese equity markets and the firming data in the Chinese economy.

Equity-Market Access Continues to Improve

Foreign investors have traditionally accessed China’s equity markets through a quota system. This made it challenging for foreign investors to access these markets, and also made the markets fairly illiquid. Following the launch of the Shanghai-Hong Kong Stock Connect program in 2014, investors have been anticipating the launch of the Shenzhen-Hong Kong Stock Connect program, which will open more than 70 percent of the market capitalization on the Shenzhen exchange to Hong Kong investors for the first time. This launch is now scheduled for Monday, December 5, and it will contribute to making mainland China’s equity markets more accessible to foreign investors. This should add to market liquidity, but it also is likely to increase the unpredictability of the already volatile Chinese equity markets.

Table 1. Profile of Shenzhen, Hong Kong and Shanghai Stock Exchanges Table 1. Profile of Shenzhen, Hong Kong and Shanghai Stock ExchangesSource: Bloomberg, 11/29/16.

Investors should note that the Shenzhen stock exchange is much more concentrated in technology sectors, as well as small and mid-capitalization companies than the Shanghai Composite or Hong Kong Stock Exchange. While Information Technology is 20 percent of the Shenzhen index and Financials represent only 5 percent, the Shanghai Composite is 28 percent Financials and only 4 percent Information Technology. The bottom line for investors is that the launch of the Shenzhen Connect program will give foreign investors better access to the fastest-growing parts of China’s economy rather than the traditional state-owned enterprises like the banks that are widely represented on the Shanghai stock exchange today.

Chart 1. Chinese Manufacturing PMI Has Improved—Will the Equity Markets Follow? Chart 1. Chinese Manufacturing PMI Has Improved—Will the Equity Markets Follow?Source: Bloomberg, 11/29/16.

Economic Data and Trade Relations

As noted, economic news also will be a key item to watch this week as China’s manufacturing PMI data will be released on Thursday. Historically, we have seen a pretty strong correlation between China’s manufacturing PMI data and the equity markets (Chart 1). The data may confirm whether the recent weakness in emerging-markets stocks is reflective of weak Chinese manufacturing data or if it is being driven more by worries of what a new U.S. administration may do to U.S.-China relationships. Our view is that the weakness has been more on the U.S.–China trade front than it is a reaction to specific weakness in economic data emanating from China.

Lastly, it will be important to watch the rhetoric around U.S.-China relationships in the coming weeks. During his first term, President Obama spoke of the U.S. “pivot” toward Asia. This pivot certainly has come under question with President-elect Trump’s strong protectionist statements. China’s President Xi Jinping met with President Obama two weeks ago and spoke of U.S.-China relationships being at a “hinge point.” A hinge is much different than a pivot and is probably the proper characterization. Like most campaign issues with President-elect Trump, we would expect his stance to be somewhat moderated relative to the strong positions taken during the campaign. This moderation would be positively received by Chinese equity markets.

Investment Implications

Over the past month, equities in China have not been hit as hard as emerging equity markets overall. Additionally, the markets rose following last Friday’s announcement of the Shenzhen Connect program launch. The currency markets have felt the brunt of worries over strained U.S.–China relationships. However, one counterbalancing impact to the threat of U.S. protectionism is the fact that the U.S. is likely to keep monetary conditions accommodative through the first half of next year. We continue to hold a favorable view on Emerging Asia equities and believe that they are the most positively positioned in the emerging-market equity asset group.

Weekly Wrap and Look Ahead

All major domestic and international indices were positive for the week. Most gained year to date.

Index Last Week’s Performance1 2016 YTD Performance
S&P 500 +1.4% +8.3%
DJIA +1.5% +9.9%
NASDAQ +1.5% +7.8%
Russell 2000 +2.4% +18.6%
MSCI EAFE +0.1% -1.6%
MSCI Emerging Markets +1.0% +10.4%
1. For the week of November 21 – November 25, 2016.
Source: Wells Fargo Investment Institute, Bloomberg, 11/25/16.

Six of 11 S&P 500 Index sectors outperformed the index. Ten of 11 managed to gain ground on the week.

Best-Performing Sectors
Sector Last Week’s Performance2
Telecom Services +3.0%
Financials +2.2%
Energy +1.9%
Worst-Performing Sectors
Sector Last Week’s Performance2
Health Care -1.2%
Consumer Staples -0.1%
Utilities +0.2%
2. For the week of November 21 – November 25, 2016.
Source: Wells Fargo Investment Institute, Bloomberg, 11/25/16.
Past performance is no guarantee of future results.

At the time of this writing, the S&P 500 Index had gained a modest 3.3 percent over the three weeks since the November 8 election. We believe that the market has continued to trade on fundamentals and on expectations in place for 2017. Investors have been looking ahead to next year for at least the past nine months (if not more) and anticipating better economic and earnings growth. The market has looked through the four consecutive quarters of negative year-over-year earnings comparisons and expected each quarter in 2016 to show earnings improvement vs. the year-ago period. And that is exactly what has happened. Earnings growth in the third quarter was up a solid 4 percent when the consensus was expecting a drop of approximately 2 percent. We continue to expect 6 to 7 percent earnings growth next year, mostly due to much better comparisons for the Energy sector.

We understand that President-elect Trump’s pro-growth proposals in the areas of tax reduction, infrastructure spending and less regulation should have a positive effect when they are implemented (big emphasis on “when”). Given that many congressional Republicans disagree with at least some components of the Trump plan, it is nothing more than one-sided speculation to assume that large tax cuts and spending programs will produce only pro-growth but no anti-growth forces in the economy, even into 2018 or 2019. There will almost certainly be a great deal of debate over most of these proposals; Congress appears very unlikely to simply “rubber stamp” what the president-elect wants to enact. For now, we advise investors to remain invested and to look for opportunities to buy on pullbacks.

Sector S&P Weighting* Wells Fargo Investment Institute Guidance
Consumer Discretionary 12.4% Overweight 14.9%
Consumer Staples 9.4% Underweight 8.5%
Energy 7.3% Underweight 4.0%
Financials 14.4% Evenweight 13.4%
Health Care 13.7% Overweight 17.2%
Industrials 10.4% Overweight 11.6%
Information Technoloy 21.0% Overweight 21.8%
Materials 2.9% Evenweight 3.0%
Telecom Services 2.5% Evenweight 2.5%
Utilities 3.1% Underweight 0.0%
Real Estate 2.8% Evenweight 3.1%
S&P 500 Earnings Estimate for 2016 $119.00
S&P 500 Earnings Estimate for 2017 $127.00
S&P 500 Year-end 2016 Target Range 2,190-2,290
*Sector weightings may not add to 100% due to rounding. Weightings as of 11/28/16 close. Targets are not guaranteed and may change.
Source: Wells Fargo Investment Institute, Bloomberg, 11/28/16.
Valuations and Fundamentals for Five Primary Equity Asset Classes Valuations and Fundamentals for Five Primary Equity Asset Classes*Enterprise Value.
Source: Wells Fargo Investment Institute, Bloomberg, 11/25/16. Developed Markets: MSCI EAFE Developed Market Index (Europe, Australasia, Far East). Emerging Markets: MSCI Emerging Markets Index.

Risk Factors

Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.

The prices of small and mid-cap company stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.

Technology and Internet-related stocks, especially of smaller, less-seasoned companies, tend to be more volatile than the overall market.


An index is unmanaged and not available for direct investment.

China Manufacturing Purchasing Managers’ Index (PMI) – is jointly published by the China Federation of Logistics & Purchasing and the National Bureau of Statistics, is a monthly survey of expected activity among is considered to be a leading indicator of manufacturing activity. Values above 50 reflect expanding activity while values below 50 reflect a contraction in activity.

DJIA is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq.

Developed Markets: MSCI EAFE Developed Market Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the U.S. and Canada. It is unmanaged and unavailable for investment. Statistics are shown in U.S. dollars and local currency.

Emerging Markets: The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 23 emerging market country indexes: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

MSCI China Index captures large and mid-cap representation across China H shares, B shares, Red Chips and P Chips. With 140 constituents, the index covers about 85% of the China equity universe.

MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The Index consists of the following 21 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

NASDAQ is an unmanaged group of the 100 biggest companies listed on the NASDAQ Composite Index. The list is updated quarterly and companies on this Index are typically representative of technology-related industries, such as computer hardware and software products, telecommunications, biotechnology and retail/wholesale trade.

Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately eight percent of the total market capitalization of the Russell 3000 Index.

Russell Midcap® Index measures the performance of the 800 smallest companies in the Russell 1000 Index, which represent approximately 25 percent of the total market capitalization of the Russell 1000® Index.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the U.S. stock market. The Index is unmanaged and not available for direct investment.

Shanghai-Hong Kong Stock Connect is a cross-boundary investment channel that connects the Shanghai Stock Exchange and the Hong Kong Stock Exchange. Under the program, investors in each market are able to trade shares on the other market using their local brokers and clearing houses.

Shenzhen Composite Index tracks stock performance of all the A-share and B-share lists on China’s Shenzhen Stock Exchange.

Global Investment Strategy (“GIS”) is a division of Wells Fargo Investment Institute, Inc. (“WFII”). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by the GIS division of Wells Fargo Investment Institute. Opinions represent GIS’ opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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