Thursday, July 30, 2009

Chinese Equity A Bubble In The Making?

Well, that should not even be a question, its a fact. The question should be for how long. Just because a market is considered expensive, does not mean one should get out immediately. It will be a tug of war. A bubble is usually because there is a concentration of liquidity and a flush of liquidity, as explained numerous times in this blog. Yesterday saw China markets doing a whipsaw, falling dramatically but still regaining some ground back. That is a prime example of a very strong momentum market. It will be volatile but the investors and players are not ready to leave the playground yet. Hence on rumours of possible tightening by the central bank, the markets will take that as an excuse to take profit and take some chips off the table. I don't think the China markets and HK market included will be paralysed so soon. Judging from the liquidity exhibited in recent IPOs in HK and Shanghai, this rally has some legs. Still, one has to react swiftly, in and out, its a traders' market not a buy and hold market.

    After falling 70% from its peak in late 2007, the Shanghai Composite Index is up more than 80% off its low in November 2008 and 70% for the year. China's total market cap has risen 122% in 2009 to more than 10 trillion yuan. Valuations have more than doubled from their lows in November, but are still well below their peak in January 2008. In July IPOs resumed after new rule changes were put in place.

  • July 10: The Shanghai Composite Index is up 70% in 2009, after falling 70% from the peak in late 2007. The Shenzhen index is up 87% in 2009. Trading on the first IPOs in nine months was halted after they jumped more than 20% from their opening price. The Chinese equity markets have rebounded on the back of the fiscal stimulus, expectations of a recovery in property markets and signs of improvement in domestic demand have given markets another boost
  • Some of the new loans extended during the Q1 surge in bank lending likely found their way into the equity market as investors seek better return on assets, this could imply that the lending surge is not being invested in sectors that will boost growth- and that stock market gains are vulnerable especially given that Chinese equity returns have become more correlated with global trends
  • China and other emerging markets have outperformed developed markets in 2009, suggesting that investors believe emerging markets have "decoupled" again. Another view is that emerging markets underperformed on the way down, and are over-performing on the way up—suggesting not decoupling but rather that they are performing like high-beta assets

  • Are Higher Valuations Sustainable?
  • Stocks on the Shanghai Index traded at 28.1 times earnings in early June 2009, more than double the 12.9 factor they traded at in Nov, but below their peak in Jan 2008 at 50 times earnings
  • Citi: Ample liquidity continues to push up asset prices. After strong lending growth through April, the market expects a slowdown in May/June. But May’s volume could be close to April’s (RMB591.8b), and June could see further growth, thanks to the non-seasonal pick-up in economic activities for the summer months
  • DBS: State-owned enterprises' profits track exports more closely than GDP growth, suggesting that profits will remain under stress even as domestic conditions improve. Sticky wages and increasing commodity input prices increase the pressure from the cost side. Further, because inflation is likely to pick up before corporate profits, SOE's will likely face tighter credit conditions before their balance sheets improve
  • Policy responses have boosted confidence and prevented further contractions of consumption and investment. Property, retail, and auto sales are healthy in volume terms, even if prices remain deflationary. The real impact of the stimulus will take time to filter through the economy and will show up in H2 2009
  • The Chinese equity market continues to be speculative because hedging tools are limited (deterring institutional investors) information on the companies is sparse. Level of government meddling in the market makes true transparency difficult Many retail investors (who led the boom in 2007) retreated to demand deposits
  • After a surge of IPOs in 07-08, there have been no new issues since Sept 08, when regulators feared new supply could further damage existing shares. The China Securities Regulatory Commission issued new regulations for listings on June 11 and has taken legal actions intended to ensure that Chinese markets are less prone to manipulation; IPOs are expected to resume soon
  • New listings and release of block shares could drain funds from existing shares, threatening this year’s gains. The rule changes are intended to increase access for retail investors to IPOs, and limit the valuation surges that followed flotations in 07-08
  • In an apparent attempt to reduce market volatility as new IPOs come online, the government is requiring that SOEs that have listed since 2005 transfer 10% of their shares to the social security fund, which will be subject to a 3-year lock-up period
  • In 2007, regulations intended to deflate Chinese equity markets were implemented (stamp tax raised from 0.1% to 0.3% in May 07), these were mostly reversed in 2008 when markets fell sharply (stamp tax repealed completely in Sept 08). In an attempt to boost existing shares, IPOs were suspended in Sept 08
  • The average daily volume on the Shanghai exchange has more than doubled to 13.6bn yuan in May 2009 from a low of 4.4bn yuan in Aug 2008

  • Sectoral Outlook
  • Citi: Consumer-facing sectors could benefit from policy shifts that would help boost domestic consumption. Auto sector profits trail sales growth, banking sector profits down y/y but show q/q momentum, cement and food/beverage sectors should outperform, and insurance sector looks positive
  • UOB: A pick-up in demand in H2 2009 should benefit energy producers. Dropping property inventories and the massive reduction in equity ratio requirement (20% from 35%) for new ordinary residential projects will boost the property sector, in turn boosting demand for steel and aluminum, as well as energy
  • Planned massive infrastructure spending on the mobile network over the next 3 years should boost the telecommunications sector. Export-oriented industries (steel, shipbuilding, coal), despite stimulus spending, are reliant on a pickup in global demand
  • Fidelity: railways, materials and the property companies may benefit from stimulus efforts. Industry leaders may benefit from consolidation. The large scale railway expansion should also boost demand for steel and cement. Conversely financial services and energy companies place more challenges ahead
  • Domestic retail sales continue to grow on the back of government subsidy programs and the wealth-effect of rising asset prices, however exports remain in contraction.
  • Chinese oil demand returned to positive growth in April, and Chinese oil firms were able to use favorable credit conditions to purchase assets abroad when oil prices were depressed

p/s photos: Suzanne Sae

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