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China Equity Markets

Dec 05, 2014
admin

The fall in commodity prices in general and the price of oil in particular has significant positive consequences for the China growth story. Cornered with western sanctions, China has been able to strike a bargain long term deal on energy with Russia. Thus this is not a temporary stimulus. The slower growth and lower inflation has prompted easing of credit conditions with a first reduction in interest rates that is imminent. Lower inflation outlook will lead to lower rates. Tying the CNY to the dollar, however loosely, causes import of deflation into China. This can only prompt restructuring of the inefficient part of the economy and drive productivity growth. China isn’t going to give up its hard won market share of global trade, while it drives demand locally.

The latest move to permit investors in Hong Kong to buy onshore stocks has fired up Chinese equities. This is only a precursor to opening up the financial markets further and making CNH freely floating. The SSE Composite Index is up 30% this year, but still 50% below the last peak in late 2007.  (http://finance.yahoo.com/echarts?s=000001.SS+Basic+Chart&t=my )

There remain problems with transparency in China and corporate governance. But we think that the authorities are and will have to clean up corporate China. This is the price one pays for inviting foreign investors. But if accomplished, the rewards are huge for the Chinese people. A wealth creating nation needs to not only save but utilise its savings in a way that capital is better allocated. Investment returns in a global economy should come from global opportunities. This is what the authorities in China appear to have grasped. There simply is not the diversity and depth of assets in China to absorb domestic savings. It is the combination of both creating bigger and more liquid equity and bond markets and allowing the Chinese citizens to also invest abroad that will bring more harmony not only to China, but to global markets in general. One cannot continue to have the second largest economy measured in GDP terms play a minor role in the flow of funds. Power comes from the supply of credit as well as creating opportunities for investments.

Oil prices may not stay low in the long term. Energy efficiency and the move to renewables is only going to accelerate as the cost of climate change forces government action to cut greenhouse gases and in the case of China make its cities fit for living.

Sensible governments manage wealth in the long term interest of their citizens. Sovereign Wealth Funds, the creation of oil reserves and possibly storing commodities such as copper in times of market distress all makes economic sense. China appears to be moving on many fronts and China is in great demand from the likes of India for help with manufacturing.

So how much can the China stock markets rally?

If the US markets and some European markets are setting record highs, there is no reason why China should not. The float of Alibaba Group (BABA) shows that home grown companies have global ambitions and global scale. BABA isn’t the only one.

Perhaps the most important lesson for emerging countries to learn is that syphoning money out of the earnings of a company is not the way to grow wealth. The secret is to make the companies grow and be a shareholder. This is a lesson for Brazil and it is a lesson for India. State controlled champions are much better off when they are listed on the exchanges and compete both for capital and return to shareholders.

This latest rally in the Chinese equity markets is not a fluke. It is supported by lower bond yields, declining inflation, flow of credit and genuine financial reform.

In June 2001 the SSE Composite Index was trading around 2,200. It closed today at 2937. The Indian stock market as measured by the SENSEX was around 3,456 in June 2001. It closed today at 28,462.

Even on a currency adjusted basis the returns in the Indian equity market have been phenomenal. China may be the dragon that has lit a fire under its equity markets.

But as we know thinks can go wrong. The journey in equity markets is never smooth. Speculators, geopolitics, unknown unknowns play havoc on the way. Corrections can be severe.

Risks have to be monitored, measured and managed.

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