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Rate Cuts Drive Next Leg of Equity Market Rally
China Macro Monitor November 2014 Rate Cuts Drive Next Leg of Equity Market Rally. This publication is a monthly report focusing on macro developments in China relevant to investors across asset classes and markets.
Summary
- Last week the People’s Bank of China (PBoC), the central bank, stepped up its fight against flagging growth and deflationary headwinds by cutting interest rates for the first time since 2012.
- The PBoC had been active this year in delivering very targeted policy easing and injecting liquidity into the banking system. However, last week’s move marks the first broad-based monetary easing action in over two years. We believe there will be more to come.
- We believe the PBoC will cut the reserve requirement ratio (RRR) as well as cut interest rates further as it aims to generate sustainable demand in the economy and ward off rising deflationary risks.
- The PBoC also increased the flexibility of banks to set deposit rates, highlighting its commitment to increasing financial market liberalisation.
- The Hong Kong-Shanghai Stock Connect opened for business earlier this month. The daily quota was hit on the first day of trading, illustrating the strength of pent up demand for domestic Chinese equities.
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PBOC CUTS POLICY RATES AND ADVANCES ON RATE LIBERALISATION
We have long argued that weak economic data and the threat of deflationary pressures will expedite policy stimulus from both the Chinese government and central bank. The PBoC has been very active in recent months in delivering targeted policy easing and injecting liquidity into the banking system. Last week’s moves however demonstrate that the central bank has stepped up its fight and marks the first time the PBoC has cut key policy rates since 2012. The PBoC cut the 1-year benchmark lending rate 40bps (to 5.6%) and cut the 1-year deposit rate by 25bps (to 2.75%).
At the same time the PBoC raised the deposit rate ceiling (the limit on deposit interest rates, expressed as a multiple of the benchmark deposit rate) to 1.2 from 1.1 times previously. Deposit caps have been a constraint on the formal banking system and have led to the growth the shadow-banking system which does not face the same draconian constraints. The moves to widen the ceiling illustrate that policy easing and liberalisation can go hand-in-hand. While the net effect on deposit rates for this first rate cut could become muted if all banks utilise the new ceiling1, the moves highlight policymakers’ commitment to supporting growth and liberalising financial markets.
We believe last week’s rate cuts will be the first in a series of cuts that will be necessary to stimulate the economy. A further 50bps could be cut in H1 2015.In addition we believe that China will cut the reserve requirement ratio (RRR) i.e. the amount of deposits and notes that banks must hold as reserves at the central bank. Cutting the RRR expands the capacity of banks to lend into the real economy. Although the PBoC cut the RRR for select banks earlier this year, we believe that a broad-based cut is now required
With shadow banks taking a back-seat, the onus is on the formal banking sector to provide financing into the economy. The banking sector therefore needs all the support it can get from the central bank.
The PBoC took further steps to liberalise interest rates by abolishing the benchmark guidance for 5-year savings rates and consolidated the benchmark guidance for loans of 1-5 years maturity. These moves allow regulated banks to attract more deposits that would have gone to shadow banks and therefore should aid their ability to lend
On 27th November, the PBoC refrained from selling repurchase agreements for the first time since July, loosening monetary policy further. It last suspended sales of repos, in the week of July 21 as initial public offerings boosted cash demand. This time the motivation seems more aligned with monetary stimuli. The sale of repos drain funds from the banking system. Indeed the PBoC could conduct reverse repos to increase liquidity in the banking system, a tool which we believe it will utilise in 2015.
The Renminbi depreciated modestly in November, helping to boost the competitiveness of Chinese exports. Exports were already been growing briskly during a period of Renminbi appreciation. The recent depreciation should act as a catalyst to extend that growth and is in line with the recent monetary easing efforts by the central bank.
HONG KONG-SHANGHAI STOCK CONNECT OPENS FOR BUSINESS
The Hong Kong-Shanghai Stock Connect programme, which allows foreigners access to the domestic equity market in China via Hong Kong, started on November 17th. This initiative marks the most substantial opening of the Chinese equity market in history. On the first day of trading, flows from Hong Kong to China hit the daily quota, in a sign of the strength of pent up demand for Chinese equity exposure. Coinciding with the opening of the Connect programme, capital gains tax on investments by foreigners has been waived for three years and the cap on HK dollar-yuan convertibility was lifted for Hong Kong residents in another significant sign of willingness to liberalise financial markets.
In June 2014, MSCI refrained from including China A-Shares into its MSCI Emerging markets Index due to concerns over difficulty in accessing the market. The Connect initiative should go a long way in alleviating these concerns. With approximately US$1.5tn benchmarked to MSCI China Emerging Markets Index, even a small allocation of 0.5% to the China A-Share market in the broader index could drive US$7.5bn into the market on the back of index replication by investors. With equity markets becoming more optimistic on index inclusion, China A-Shares have staged a rally.
As a point of reference, the MSCI United Arab Emirates Net TR USD index rose over 90% between the time MSCI announced UAE stocks would enter its Emerging Market Index and actual inclusion (see shaded area of chart). While the Chinese and UAE markets are vastly different in size and composition and therefore limits comparability, we believe the increasing probability of index inclusion will bode well for China A-Shares.
The Hong Kong-Shanghai Connect programme does not open the Shenzhen market up to foreigners and for that reason many investors prefer investment products benchmarked to broad indices with exposure to all A-Shares such as the MSCI China A-Share Index.
1 If banks fully utilize the new deposit ceiling, the new deposit rate will be 2.75%*1.2 = 3.3%, same as 3.00%*1.1 =3.3% under the old deposit rate and deposit ceiling.
Important Information
This communication has been provided by ETF Securities (UK) Limited (”ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the ”FCA”).
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IncomeShares passed three milestones in August. Assets under management climbed to almost $66 million, cumulative fund flows topped $72 million, and turnover across London and Xetra listings reached over $27 million. Palantir paid the highest annualised distribution yield at 57.11%. The sections below break the numbers down in more detail.
Cumulative fund flows
Fund flows track how much money investors put into or take out of IncomeShares ETPs (exchange-traded products). Positive flows mean more money coming in than going out – a sign of demand for the products.
Flows have risen every month this year. In January, they stood at $13.7 million. By the end of August, they reached $72.4 million. That’s over $8 million of new money added in August alone – the biggest increase since May.
Trading turnover
Turnover is the total dollar value of IncomeShares ETPs bought and sold on the exchanges. Higher turnover means more activity and liquidity for investors.
Turnover reached $27.3 million in August – the highest on record and more than double January’s $13.0 million. London listings (USD and GBP combined) made up $14.2 million, with Xetra listings close behind at $13.1 million. Both exchanges have seen steady increases through 2025, showing rising interest in income options strategies across the board.
Note: Figures use IDC FX rates as of the August month-end to convert GBP and EUR into USD. We apply the same August rates to all prior months to compare turnover on a like-for-like basis.
Assets under management (AUM)
AUM is the total value of assets held across all IncomeShares ETPs. It grows when new investors buy in, or when the underlying assets rise in value.
AUM grew from $13.8 million in January to $65.8 million at the end of August. It was also $8 million more than in July. Steady inflows and consistent income distributions are helping the product range build scale.
Distribution yields
Distribution yields represent the annualised income paid to investors as a percentage of the current NAV (net asset value), based on the latest month’s yield. IncomeShares ETPs aim to generate this income from selling options. Yields change each month depending on strategy performance and market volatility.
Annualised August yields (ranked highest to lowest):
• Palantir Options ETP (PLTY): 57.11%
• Nasdaq 100 Options ETP (QQQY): 46.44%
• Coinbase Options ETP (COIY): 43.60%
• AMD Options ETP (AMDY): 41.43%
• Tesla Options ETP (TSLI): 40.97%
• Broadcom Options ETP (AVGY): 40.96%
• MicroStrategy Options ETP (MSTY): 37.61%
• Alibaba Options ETP (BABY): 35.90%
• S&P 500 Options ETP (SPYY): 32.95%
• NVIDIA Options ETP (NVDI): 28.42%
• Alphabet Options ETP (GOOI): 18.15%
• Magnificent 7 Options ETP (MAGO): 16.87%
• Apple Options ETP (AAPPY): 15.55%
• 20+ Year Treasury Options ETP (TLTY): 12.38%
• Amazon Options ETP (AMZI): 12.00%
• Silver+ Yield Options ETP (SLVY): 11.56%
• Meta Options ETP (METY): 11.32%
• Gold+ Yield Options ETP (GLDI): 6.74%
• Microsoft Options ETP (MSFY): 6.54%
Our Palantir ETP topped the list with an annualised yield of 57.11% for August, up from 30.57% in July. The stock was volatile in August, trading between $142 and $190. That wider range increased option premiums, which boosted the ETP’s yield. The ETP sells put options on Palantir stock and holds shares – the strategy used for all our single stock ETPs and the Magnificent 7 product.
The Nasdaq 100 ETP paid an annualised yield of 46.44% in August, up slightly from 44.52% in July. At the other end, Gold+ and Microsoft stayed below 7%, reflecting relatively calmer conditions in their underlying assets.
The table below shows the annalised distribution yields for all IncomeShares ETPs so far this year. Note that the bottom eight ETPs launched in late June, so they only have yields for July and August.
Key takeaways
• Fund flows climbed to $72.4 million, with August adding more than $8 million.
• Turnover hit a record $27.3 million, split almost evenly between London and Xetra.
• Palantir topped the yield table at 57%, with Nasdaq 100 and Coinbase also paying above 40%.
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