From Citi via FTAlphaville as the Shanghai rebound pushes to new highs:
Sentiment indexes are in despair and investors want to get more bearish still — It is rather strange that an asset class which is already in despair according to our sentiment indicators, and where valuations range from 1 stdev-below-mean to mean in terms of P/BV, and yet fails to generate much investor interest. On the contrary, as sentiment has worsened and valuations have fallen, investors have become more dismissive of the asset class. This is no truer than when it comes to the China. A market, which is either in a bubble or collapsing, and sometimes doing both the same day according to the bears…
The Chinese market corrects and the bears come out of hibernation all at once. Having been temporarily silenced by the rising market, all one needs to do is open a reputable newspaper or look at Bloomberg and you’ll get your fill of China doom and gloom. And while the momentum is down, why not extend the pessimism to all EM, which after all is just one big China trade anyhow? China and the EM asset class is doomed and for all the pulp and paper in the world there aren’t sufficient hankies in the world to mop up this mess, it would seem.
…While the A share market declined by 24% off the peak, it is still worth remembering that China is still up for the year. The CSI 300 is up 18% in US$ terms, Shanghai A shares are up 23%: sure, both markets were up a lot more a few weeks ago but those performance numbers are still enviable compared to many other markets (see Figure 3). The SPX is up 3.4%, NASDAQ 10.2%, the Euro Stoxx is up 6.9% in US$ terms and the N225 is up 14.2%, again in US$ terms. In percentage terms in EM, only Russia and Hungary, up 22% and 27% in US$, have outperformed the CSI 300, while many markets in EM are down double digits: take Columbia off by 25%, Peru off by 12%, Turkey down by 19, Indonesia off by 15% and Brazil off 15%. So, for all the talk of an imminent blow-up, the Chinese markets have actually done rather well. Our most likely scenario for the Chinese economy, should reforms fail, is the Japanisation of the economy with growth slowing progressively until there is none. Given that China borrows from itself and runs a CA surplus, a progressive ossification of the economy and financial system is still a more likely outcome than the sharp sudden crisis so often seen in EM, the latter being mostly CA deficit-driven adjustments. China remains a net creditor to the world.
In terms of relative expense, China relative to all others is slightly dear vs Korea and Thailand, has the same valuation vs HK but is cheaper than the Philippines, India, Indonesia and Mexico. Six months ago, many of those markets were also well and truly in the glamour quadrant but, because the general consensus owned most of them, the markets were never written off as expensive or investment bubbles. As a species, we do a far better job at rationalizing than being rational. So, for those markets which investors own, “rational “reasons are found as to why markets in the glamour quadrant should be owned. Since the general consensus is that China as a market is to be disliked, investors pounce on the fact that it is a glamour market, forgetting that within their portfolios there are a number of glamour markets.
It is interesting to look up the number of news stories featuring China risk on Bloomberg and P/BV (see Figure 5). Really it is quite odd that during the run up in the Chinese market and when it became clear that things were unsustainable, there were fewer stories about China and risk than there are now, when valuations are one third of what they were at their peak. The time to have been fearful of China and use the word “risk” liberally was in 2007, but no, now China is risky. The data from Bloomberg are similar to what our implied earnings growth model is telling us. Investors are panicked to a degree, but at the point where valuations are not excessive.
The 24% decline in the A share market from the recent peak tends to get portrayed in the media as an indication that all is not well with the Chinese economy. Well, if the A share market was such a great indicator as to the state of the real economy, then the Chinese economy is about the most dynamic/flexible that the world has ever seen (see Figure 13). Eighteen months ago the economy was in a slumber, it then awoke, beat Hussain Bolt in the 100 meters and then suffered cardiac arrest. The end.
…If we look at the performance of the A, H share and shares of DM companies which have at least 25% of revenue from China and you get a very different picture of what is going on in the Chinese economy (see Figure 16). Early on in 2014, the A share market was telling us that the Chinese economy was doing rather poorly, or at least the A shares interpretation of the performance was worse than that of the foreign shares with 25% sales exposure to China. Come early 2015, the A shares thought the Chinese economy was on the move at the point where the foreign shares thought the economy was getting worse rather than better. H shares on the other hand were of the view that the truth lay somewhere between the two. Post the correction, the A shares are still saying the economy in aggregate is okay, H shares are telling us that the economy is flat-lining (similar to the PMI) and the foreign shares with 25% China exposure are telling us what we can read daily, which is that China is in real trouble.
By the way, it I were a listed company and my second-quarter earnings are about to miss, I would blame it on China. No one would question it as it fits in perfectly in to the negative China narrative. The latter is where the overseas investors get their read on the China economy from, the locals have limited options as to where to put their investments and the H-share investors, as we saw above per their weightings, are clearly disinterested. The A share market is thus more indicative of the domestic retail investors’ liquidity position than being a call on the direction of the economy.
The three ingredients of a bubble are credit, time and valuations: one can say that the A share market has had some of the credit expansion but not enough time nor valuations at sufficiently extreme levels. With equities making up less than 10% of household wealth in China (real estate and bank deposits are bigger part of household wealth), it is highly unlikely that consumption patterns will be impacted greatly. As we said above, just look at the size of deposits and the falling rate environment and that tells you that there is still plenty of domestic liquidity to drive the A share market higher. Out of the two, we continue to view the H share market as a much more attractive way to play the recovery in China at this stage.
Some good points there but no cigar in my view:
- the bust won’t wreck the economy but it will slow it faster than otherwise;
- it was a bubble owing to the steepness of ascent, over-valuations and the levels of margin credit driving it, and
- it’s fine to dress down the bears but unless you address the wholesale destruction of market liquidity in the “save” then you’re missing the entire point. What good is a market you can’t exit at the most crucial moments? It doesn’t matter if prices rise or fall from this point. You’re not betting on anything other than the CCP’s ability to control the price. That is not investment, sorry!
