Chinese equities – a steady bull market? Despite risks, stocks will continue to rise in coming months

 
Luis Barrueto
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China’s central bank wants to see a “healthy” stock market
Despite a six per cent sell-off on Thursday, the Chinese equity markets made fresh gains yesterday. Shanghai’s CSI 300 index rose 4.86 per cent to 5,076.18, while the Shanghai Composite Index gained 4.72 per cent to 4,828.74, following a 136.9 per cent increase in the last 12 months.

These gains came despite relatively weak market data. The official manufacturing PMI edged up to 50.2 from 50.1 in April (indicating expansion), but a survey by HSBC and Markit Economics – which focuses on small and mid-sized firms – stayed in contraction for a third month at 49.2, despite beating the 49.1 figure from April.

Since last summer, however, investors have read signs of the economy’s continued slowdown as an indication of further policy easing from the Chinese authorities. The central bank has already cut interest rates three times in six months, and many analysts expect broader macro stimulus to cushion the slowdown and boost the equity markets. But just how long is this likely to continue?

According to Nomura, several structural factors underpin the current equity rally, which they see extending well into 2017. Chinese investors are transferring their deposits at banks and money invested in fixed-income wealth management and trust products to equities. More mainland funds are also likely to flow to Hong Kong, but this will take time.

Despite this, there are several potential risks. First is the use of borrowed capital to buy securities. The value of stocks bought on margin financing reached 16 per cent of total turnover in the Shanghai and Shenzhen stock exchanges in March 2015. “A steady bull market will help China deleverage, but a rushed bubble on borrowed money will make things worse,” Nomura analysts say in a recent note.

Another potential risk remains a downturn in economic data without an appropriate policy response, says Chris Beauchamp, market analyst at IG. But while caution is still warranted with regard to the long-term outlook, so far it seems that policy will remain accommodative. “The recent bout of volatility is a reflection more on valuation concerns than the worry that policy is about to be shifted in a tighter direction,” he says.

Overall, the future looks bright for Chinese stocks. “Liquidity is still on the march higher and currency liberalisation measures are also likely to promote a further rally in the second half of the year,” according to Beauchamp. “Lower oil prices and a greater degree of connectivity between China and its neighbours will also boost the underlying rationale for further increases in the stock market,” he adds.

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