AS investors pulled back sharply from China's stock market on Tuesday afternoon after a multi-year high on Monday, some observers said that they believed the rally still had legs. (see infographic)
Fan Cheuk Wan, Credit Suisse Private Banking and Wealth Management's Asia-Pacific chief investment officer, said on Tuesday evening: "Today's market action was a healthy correction."
The market is now pricing in Shanghai-listed companies to trade at just 9.6 times next year's earnings, versus a 10-year average of 14.1 times, she pointed out.
"A-Shares will have room to re-rate close to their historical average, but not to their (2007) peak," she said.
The Shanghai Stock Exchange Composite Index fell more than 200 points from its intra-day peak on Tuesday to close at 2,856.27 points, down 5.4 per cent for the day, after having closed at above 3,000 points on Monday for the first time in three years.
Despite yesterday's fall, China's stock market is still the world's best performer this year; it is up 40 per cent year to date.
A rule introduced by clearing house China Securities Depository and Clearing Corporation (CSDC) late on Monday had temporarily disqualified the use of riskier bonds as collateral for loans obtained through repurchase agreements. CSDC said on its website that for risk-management reasons, only AAA-rated corporate bonds and bonds issued by firms rated AA and above could be used.
An unnamed official said on Tuesday on the CSDC website that he did not expect the move to substantially affect equity markets, as bond and equity markets were relatively isolated from each other, and had differences in market characteristics, investor structure and funding preferences.
Nevertheless, lower-rated bonds and the stock market fell yesterday as some liquidity was taken out.
Ms Fan said: "Corporate bonds repo was a key source of margin financing, which drove the crazy A-Share turnover over the past two weeks."
Investors had returned to the A-Share market in droves in the past fortnight, on the back of China's central bank surprising the market on Nov 21 with an interest rate cut. The one-year lending rate fell from 6 per cent to 5.6 per cent as China tried to maintain growth and promote employment, even as its economy slowed.
Tan Eng Teck, senior portfolio manager at fund house Nikko AM Asia, said that in an environment where the cost of capital comes down, "valuations can be stretched a bit". "I think 15 times (forward earnings) is easily achievable," he said of the Shanghai Stock Exchange Composite Index.
Utilities and property companies could save on interest costs, driving their profits up; banks will face a smaller non-performing loan burden.
Mr Tan said: "The positive knock-on effect on financial-related stuff is very powerful . . . But there are losers in this environment as well. Some healthcare stocks, which have been our strongest picks, saw some profit-taking in the short-run, even as they would benefit in the longer run."
On Tuesday, the hardest-hit A-Shares were banks and insurers. China Life Insurance, Ping An Insurance and China's "Big Four" banks fell by between 8 per cent and the maximum allowable 10 per cent. Oil and gas producer PetroChina, which has had a surge, fell 8 per cent, but brokerage Citic Securities gained 4 per cent.
Listed brokers announced results in November that were 8-10 times better than a year ago, Mr Tan noted. Official data showed that Chinese retail investors opened over a million brokerage accounts in November.
Some insurers and brokers still trade at "very tame" valuations and could surprise on the upside, Mr Tan said. But some infrastructure equipment providers such as excavator sellers look pricey; their earnings are still down but their stocks were up 50 to 60 per cent, he said.
Corrine Png, head of regional transportation research at JP Morgan, said that she was bullish on Chinese airlines, many of which did not hedge fuel prices and were thus likely to benefit from the lower oil prices. "Our top pick is Air China," she said.
Credit Suisse's Ms Fan said that a rate cut reduced the risk of a hard landing for the Chinese economy that was previously priced in. Credit Suisse expects rates to be cut by another 40 basis points in the next year to 5.2 per cent, with other easing measures potentially on the way.
She said that China's macroeconomic story remained unchanged, with overcapacity in the industrial sector. She is thus cautious on metals, mining and commodities stocks. But consumer-related, technology and Internet stocks could benefit along with brokers and diversified financials, she said.
Chinese institutional investors, such as insurance companies and fund houses, were also involved in the rally, as they think government support will drive stock valuations up, she added.
Regulators are planning to let banks' wealth management funds invest directly in the domestic stock and bond markets, reports said at the end of last week. The move comes on top of the Shanghai-Hong Kong Stock Connect programme in November, which allows foreign investors to directly buy stocks on the Shanghai Stock Exchange.
Asian stocks largely fell yesterday, with Singapore's Straits Times Index a rare exception. European stocks opened lower.