01/2015-
China stocks raced to a new high in 2014 as retail investors shrugged off recent data pointing to a weak economy that may see GDP slow from a low 7.5% to a lower 7%. The Shanghai Composite or SHC rose a whopping 50% to close at 3,234 points, up from 2,000 points barely 7 months ago.
Following the PBOC recent interest rate cut on 21st Nov 2014, the first in the past 2 years, investors appear to believe that a new fresh easing cycle is likely to kick-in and continue into the current year.
This could set the stage for a long-awaited economic up climb as an ailing real estate market has dragged down linked industries like steel, construction, metals and transportation. The consumer industries like retail, consumer staples and consumer durables were also negatively affected as the anti-corruption drive continued to take its toils.
Not surprisingly, the Chinese stock market has entered into what I term a “Hot air Cool steam” stage where the markets are likely to be propelled higher on worsening economic numbers, be it export or import numbers, CPI, Retail sales or GDP.
The market rally took a breather on Tuesday 9th Dec 2014 when it plunged 163 point or 5.43% which was triggered by a move by regulators to stop low-quality bonds being used as collateral to back short-term loans. Essentially, bonds rated AAA or sold by issuers graded lower than AA can no longer be used as collateral for loans issued as part of bond repurchase agreements.
This had prompted a sell-off in the markets as many retail investors had funded their stock purchases on margin or credit provided by brokerages that are now at risk of being withdrawn as financial authorities seek to stamp out soaring speculation.
Prior to the correction, an astonishing 97,000 stock trading accounts were opened every day from end-November which propelled the turnover to hit a record RMB640 billion on Friday 6th Dec 2014. This is almost 6 times the average of RMB116 billion for all of 2014!
The breather lasted for days before resuming again and henceforth, the SHC has surged another 378 points to close at 3,234 at year-end 2014 compared to 2,856 points on Tuesday 9th Dec 2014.
Defenders of the rally are of the view that the current rally reflects the confidence in the reform efforts of President Xi Jinping. Not surprisingly, the shares that have performed well mainly reflected the growth model that China’s leaders say they want to leave behind.
The strongest case for the current bull market is that valuations have not gone berserk. The SHC is currently valued at 9.8x prospective PER against 16x for the Dow Jones and 14x for Japan and Singapore. Also, measured against its 10-year mean of 14x, the SHC is certainly not expensive.
To me, the most interesting aspect of this current SHC rally is not so much the magnitude of the rise, but the rapid rise of leverage in this current domino-card effect rally. Margin trading barely existed in the Mainland 2 years ago, but it has grown tremendously since regulators authorized it as part of the measures to boost its lackadaisical and moribund stock market which had languished since the aftermath of the Global Financial Crisis in 2008.
The role of banks in this current rally is also worth closer circumspection. Banks now provide quasi-financing businesses to retail investors which has reached an estimated RMB500 billion. The real economic fundamentals certainly cannot underpin the SHC rapid rise, but leverage certainly has certainly raised the foundation.
Certain recent initiatives like the HK-Shanghai stock connect and lower interest rates are certainly helping to blow bigger bubbles in the SHC. Thus, while I remain optimistic of the SHC in the coming year, I am getting to the edge where I would continue to trim stocks in my portfolio that have delivered me handsome returns of more than 50% in the past 7 months.
Happy 2015!
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