If you missed the recent US stock market rally or you have accumulated some cash and want to invest in an inexpensive but growing stock market, perhaps, you should consider the Shanghai Stock Market in 2015.
The benchmark Shanghai Composite Index (SSECI) has gained nearly 20% over the past four weeks, triggered by Beijing’s first (a surprise) interest-rate cut in more than 2 years (Nov 21) and an earlier launch of a trading link between the Shanghai and Hong Kong exchanges (Nov 17).
You can see from the following chart. Literally, the index stayed around 2,000 for long long time until the break-out this summer. 2,000 kind of sets the floor technically.
Couple months ago, I authored several blog posts to discuss my personal view why the Shanghai stock market was undervalued (still is) and recommended some investment ideas in the A-Shares-related ETFs. Below I discussed 5 factors contributing to my prediction for the Shanghai A-Shares Index to reach at least 4,000 points in 2015, which implies 33% upsides from current level. By all means, we are just at the beginning of the bull market for Shanghai Stock Market.
1. China stock market is the 2nd cheapest in the world
(Source: Telegraph)
According to Telegraph’s research in June (above), to be named “cheap”, markets had to be trading below their own historic valuation across all three measures (i.e. P/E, Cyclically adjusted P/E, and P/B ratios. As the map shows, only a handful of stock markets managed to achieve this feat – Greece, China, Hong Kong, India, Japan, Russia and Turkey.
Sometimes markets are cheap because of political uncertainty. Russia certainly falls into this category with the cheapest P/B ratio. Japan is repeating US Fed’s QE strategy to rescue the country from falling back to deflation. So when I diversify my portfolio, I am tempted to invest in India and/or China.
As of Dec 19th, the Shanghai Composite is valued at 11.5 times 12-month projected earnings, the highest level in 3 years.
China definitely has its own many problems (shadowing banking, bad loans, ghost town/real estates, slowing export, etc.) to worry about. However, in terms of political, economic, currency stability and size of foreign reserve, I’d argue China is certainly much better than India.
2. Shanghai Stock Market is prone to become the biggest in the world
Based on 2011 data, the Shanghai Stock Exchange (SSE) was ranked at the sixth place in the Top Ten Stock Exchanges in the world by market capitalization.
(Source: Marketwatch 2011)
Trading volumes on Dec 17th in the Shanghai gauge was 43% higher than the 30-day average. The value of equities changing hands on mainland exchanges surged to 1.24 trillion yuan (US $200 billion) on Dec. 9, almost five times the one-year average, which is the biggest single-day figure among the top ten stock exchanges in the world. For comparison, the average daily trading value was approximately US $163 billion in 2013 on NYSE.
Important fact to remember is that majority (>70%) of SSE’s trading volume has been driven by local retail investors. Therefore, two weeks after the surprise interest rate cut, China Securities Depository and Clearing (which clears and settles stock trades) announced that 495,819 new investor accounts were opened on the Shanghai bourse — twice the rate before the move. TV news reported that hundreds of people were lining up at some brokerage bank offices to open new accounts.
Assume only 10% of the China population has a brokerage account and each account has $50,000 yuan, i.e. 1.357 billion x 10% x $50K = 6.785 trillion yuan (US $1.1 trillion) market capitalization in the China stock market. Sooner than later, China’s stock market will be bigger than that of USA.
Chinese are famed for high saving rate and in the past buying real estates properties is their major investment destination. But now property owners, who put off by newfound sluggishness in the real estates market, are pouring their money into stock markets in search of higher returns.
As everyone has seen the wealth effects, retail investors want to follow what others do, funds on the sidelines flow in from different channels since the interest rate cut made deposits and other investments less attractive.
3. Balance of margin trading reached $151 billion
Trading on margin magnifies the potential gains for investors if shares rise, but deepens losses if they fall. On Dec 13th, margin trading volume has been topping records in recent sessions, and came to about 940 billion yuan ($151 billion), up >30% from November 21 – interest rate cut.
China investors have found it increasingly easier to take on such leveraged bets in recent years after brokerages gradually reduced the minimum amount of assets required for margin trading to as low as 50,000 yuan ($8,085) compared with 500,000 yuan when regulators launched the program in 2010.
From my conversation with my hedge fund community in mainland China, I was told that general retail investors can leverage up to 3x of their holding stocks and for biggest private clients, they can leverage up to 10x with their collaterals like bonds, stocks and/or physical assets.
The China Securities Regulatory Commission announced on Dec 13th that it will start on-site inspections of margin trading at securities companies. It is also reviewing existing regulations and will start the public comment process soon. The stricter controls on margin trading could be sobering retail investors here.
When this news broke, it caught many investors off guard with index’s biggest single-day drop (5.4%) in more than 5 years. However, when the Commission later said no immediate violation was found last week (Dec 17th), the stock market immediately soared 3% and continued on its rally.
4. Self-reinforcing optimism
Chinese markets have underperformed in comparison with the rest of the world for years, and in late August 2014 the official Xinhua news agency sought to talk them up, publishing nine articles within four days highlighting low valuations and the need to “reinvigorate” the stock market to “revitalise” the domestic economy.
The seems to have convinced many that the government was determined to see the market rise,” said Williams of Capital Economics. The “resulting enthusiasm has to some extent now become self-reinforcing”.
It is indisputable fact that the current Chinese leaders have determined to move faster to globalize their currency and economy. So, we should see continued increase of foreign institutional investors participating in mainland China stock market.
Many analysts also said that the Chinese government purposely orchestrated this stock market bull scenario to boost consumer sentiments, in turn to increase internal consumption to compensate for the drop in export and infrastructure investment.
Look around the world, China is the only country with the largest foreign reserve. Current one-year lending rate stands at 5.6% after the surprise rate cut in Nov, so it implies China can continue to reduce its lending rate to alleviate high financing costs for corporations, especially for small- and medium-sized enterprises (SMEs), and further liberalize the financial market.
5. Inclusion of A-Shares Index in the MSCI Emerging Market Index
Please read my previous post about this topic: Speculation that relaxed capital controls will entice index providers including MSCI Inc. to incorporate China’s local shares into global gauges is also attracting investors. Many suspect that it will happen in 2015. If yes, China alone could comprise 30 to 50 % of the developing-nation gauge in the next decade.
Which A-Shares Sector is Hot?
The CSI 300 financial sub-index jumped over 53 percent surge over the past month, the most among the 10 industry groups. Some of my fund manager friends have suggested the major brokerage firms, such as Citic Securities (600030), Haitong Securities (600837), even though their shares have doubled over the past month on speculation a jump in trading and demand for margin trading will boost profit. Any positive earning surprises will trigger a 10-15% upside from today’s price.
Similar to the brokerage firms, major banks (like ICBC, China Construction Bank) and insurance companies advanced 20% or more in past 4 weeks. Some analysts say big companies are targets for institutions to push the overall index higher. I personally stay away from all the banks because their bad loans and shadow banking problems are hidden bombs. They still worry me without a clear plan of how they will / can off load and fix those issues.
At micro level, here’re two A-Shares companies I am studying:
– China Railway Construction Corp. (601168) — SOE under restructuring and government blessing to expand oversea market
– Guangzhou Baiyunshan Pharmaceutical Co. (600332) — the first to be approved to produce generic Viagra in China
Besides the ones mentioned above, retail investors should be better off by investing in A-Shares ETFs. More info can be found in my previous post. You can find 23 H-Share ETFs in US which are placed in the China Equities ETF (etfdb.com). The famous ones are FXI, MCHI, GXC, and KWEB; Hong Kong listed iShares FTSE A50 China Index ETF (2823.HK) and CSOP A50 ETF (2822.hk).
Conclusion
In summary, I honestly don’t think China has solved all their fundamental problems in their financial system and economy. But again, will there be a Hard-Landing? My answer is NO. Even though future GDP growth won’t be 7.5% or even 7%, following US’s Fed policy, China is more capable of using its monetary policy to orchestrate a controlled recovery. We shall see more recovery measures to be announced next year, the China bull market continues the momentum into 2015.
Value Investing Fund (VIF) 