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China stocks on a bull run, but for how long?

There are signs the market may be overheating, which could mean volatility ahead
Monday, May 25, 2015 - 05:50
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Fuelled by implicit government support and incentives, China's markets have been on a surge similar to the one in 2007 and which has now trickled into neighbouring Hong Kong. While there is still room for shares to rise, analysts say that regulators will be careful to avoid a bursting of the bubble as in 2008.

Beijing

FUELLED by implicit government support and incentives, China's markets have been on a surge similar to the one in 2007 and which has now trickled into neighbouring Hong Kong. While there is still room for shares to rise, analysts say that regulators will be careful to avoid a bursting of the bubble as in 2008.

"Since China's first rate cuts in November 2014, Chinese equities (both onshore and offshore) continue to do well on expectations that the monetary easing and the proactive policy measures will boost growth," said BNP Paribas in a recent note to clients.

Despite a slowdown in the economy, both the Shanghai and Shenzhen markets have been rising since the end of last year when government newspapers said shares were "cheap" - investors understood this as a signal to step in and buy into the lacklustre stock markets. That was backed up by monetary and regulatory easing and a general sentiment that stock markets were the new place to invest savings amid the slump in the property market.

To support the market, China reduced fees by more than half for individuals and institutions to open share accounts. At the same time, the futures exchange cut margin requirements for equity-index contracts.

Last month regulators encouraged trading by raising the number of brokerage accounts each investor can hold from one to 20. That resulted in the number of new accounts opening in the week ending April 24 jumping 28 per cent over the previous week to 4.1 million.

"The market rally has been stronger than we expected, driven by monetary easing, a lowering of the risk premium and expectations of a reform dividend," said Francis Leung, equity analyst with CLSA.

The question is: Is this boom heading for the bust scenario of 2008 when the bubble collapsed, leaving many angry retailers?

Not really, analysts say, as Beijing has learnt its lesson from 2008. For one thing, the bull run has been good for the economy by helping to channel savings otherwise left sleeping in bank accounts at close to zero rates. It has also put the stock market at the forefront as an alternative to banks to raise funds and invest savings.

"The strong performance of the financial sector helps explain why GDP growth slowed by much less in Q1 than many monthly activity series, such as the data on industrial production, implied," said Mark Williams of Capital Economics.

In total, financial services contributed 1.3 percentage points to last quarter's 7 per cent gross domestic product growth. The government will not want that percentage to fall.

Stock markets are also where indebted corporates have been raising cheap funds to repay debts, a significant shift in attitude and a sign of a maturing stock market. As an example, China Eastern Airlines said last month that it will sell as much as 15 billion yuan (S$3.2 billion) of stock to fund the purchase of 23 planes and pay off debt.

There are signs, however, that the market may be overheating, which could mean volatility ahead and cloudy days for investors as the government juggles with the need to support the economy and avoid a stockmarket crash. ChiNext, the small-cap board, has a trailing price to earnings ratio of 90, more than double that of Internet stocks at the peak of America's dotcom bubble in 2000.

And leverage has soared. Outstanding loans to stock investors reached a record 1.67 trillion yuan as at April 13, up some 300 per cent from a year earlier.

Meanwhile, the People's Daily, the same newspaper that said stocks were "cheap", now advocates a more prudent stance. In a recent editorial, it warned that investors should remain cautious and said stock trading is a "high-risk" activity.

"To prevent the equity market from surging to unreasonable levels, the Chinese government has tried to divert liquidity to the South (Hong Kong) and there is a chance for them to implement some short-term cooling measures to extend the bull run to a longer-term horizon," BNP Paribas said.

But as the market matures, there is still plenty of room on the upside. The amount of Chinese money in equities is among the lowest in the world. Equity markets account for only 11 per cent of China's M2 money supply. And more monetary easing is expected in the form of reserve ratio cuts in the coming quarters.

"We are concerned that the government has been overzealous in promoting the stock market, allowing margin financing to reach record levels, inflating a bubble. However, it is likely to be more proactive in managing this given the lessons it learnt from 2007," said CLSA's Mr Leung. "The government is already preparing policy to dampen the market, but we believe this will only result in a pullback as the PBOC will continue to cut rates."

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