Our Opinion: 2015

Chinese equities : Crash looming?

Stock markets don’t always reflect fundamentals. China, for instance. Annual growth is running at its slowest pace since 1990. But stocks have surged. In the last three months of 2014, the Shanghai Composite index leapt by 37%. In the first quarter to this year, it grew a further 6% to take it to a six-year high.

Recent data shows that growth could well under-shoot this years 7% target. The government immediately assured investors that it would keep growth in a ‘reasonable range’ and accelerate stimulus efforts if the downturn hurts employment and income. All this underpins the feel good factor.

The Reserve requirement ration (stating how much cash Banks must set aside) has been cut, boosting borrowing. Debt is rising faster than growth, but the Government is trying to avoid another debt binge. In the short term, however, monetary policy remains loose. There has been another scheme that has supported stock market valuations since its launch last year – the Stock Connect. This scheme allows foreign investors access to China’ domestic stocks. In a short time, foreign investment in China’s markets has grown by more than 10%.

Opening up China’s market also means that it should become eligible for inclusion in international benchmarks, like the MSCI. Patrick Ho at AMP Capital said, “that would prompt a massive influx of passive funds.” Locals have also been drawn to stocks as a more attractive home for their savings than property, because of the latest downturn in real estate values.

The market looks vulnerable in the short term, after such a strong run. This is especially true since many investors have borrowed to buy. This ‘margin debt’ has hit a record $141bn.

The cyclically adjusted price/earnings ratio is 14, suggesting that valuations still look reasonable over the longer term as China’s economy evolves.