Chinese stock market
The recent surge in the Chinese stock market has allowed it to claim the title of the best performing major stock market in the world (+38.2% in US$ versus +34.5% for the Indian stock market). This has taken place despite continued widespread concerns (especially in the Western media) about a China hard landing and an imminent implosion of its property bubble. Morgan Stanley, recently publish two reports making the case for the commencement of secular bull market in China, which makes some interesting points and clarifies some prevailing misconceptions about the local stock market. To summarise:
-The China A-shares market has delivered superior dollar returns since 2000 : 12% per annum for Shenzhen-A and 8% per annum for Shanghai-A outperforming the U.S., Europe, Japan and Hong Kong (contrary to popular perceptions that the Chinese stock market has vastly underperformed-see chart below!).
-The capitalization of China’s A-share market has tripled since 2009 reaching $ 5 trillion, while the free float has quadrupled to $1.6 trillion (see chart below).
-Year-to-date until October 2014, the Chinese stock market (+8.0% Shanghai, +15.8% Shenzhen) has outperformed other domestic asset classes like real estate (+0.2%), bank deposits (+2.0%) and wealth management (i.e. trust) products (+5.9%).
-This is a reversal of the trend since 2008, when the stock market significantly underperformed (-12.4% Shanghai p.a., -4.3% Shenzhen p.a.) the real estate market (+14% p.a), bank deposits (+3.0% p.a.) and wealth management products (+8.8% p.a.). This drove private investors away from stocks and into housing and wealth management products.
-This reversal has been supported by the imposition of regulatory measures to cool the property market and impose restrictions on trust products, the government’s effort to support the stock market through official statements (in August and September), loosening requirements for new account openings and margin funding, and better access to foreign investors through expansion of QFII and RQFII and implementation of the MMA scheme.
-Since April 2014 China A shares have rallied and this has continued, even as the MSCI China and Hang Seng indices have corrected since September, following concerns about an economic slowdown in China and the demonstrations in Hong Kong (see chart below).
-The rally is the stock market has been enthusiastically embraced by local investors, as illustrated by the number of new account openings which have surged up in recent months (see chart below) and the daily trading volume on the stock exchanges which are a record high (see second chart below).
-To develop target prices for 2015, projections of the two key components – EPS growth and P/E multiple are required. EPS growth is assumed to be 10% which is well below the 15.4% historical average but closer to the average over the last few years. Noting that changes in the P/E multiples have been a more important driver of stock market returns than changes in EPS , P/E multiple scenarios are developed using historical analysis as well as using the S & P 500 and the Indian stock market as benchmarks.
-With the Shanghai-A currently trading at a P/E multiple of 14.2 x 12-month trailing earnings, which is a 35% discount to its 10-year average (see chart below), and assuming it reverts to its historical average of 21.8x , the upside for the stock market is 70% from current levels (as of December 5, ‘14).
- If the Shanghai-A multiple goes back to it 10-year low (i.e. a 1 std move below the historical average), then the downside is 28% from current levels.
-Assuming the Shanghai-A multiple moves higher by 1 std over its 10-year average then the upside is 165% from current levels.
- If the Shanghai-A multiple reaches its 2007 peak of 71.4x, then the upside is 450% from current levels.
-Assuming the Shanghai-A multiple reaches the S&P 500 level of 18.4x then the upside is 42% from now, and if it reaches the India-Nifty level of 21.8x its upside is 70% from now.
-Great research which makes a convincing bull case for Chinese stocks. The Chinese stock market does appear to be at the early stages of a secular bull market which could run until the end of this decade and perhaps even beyond. There will surely be cyclical bear markets along the way, but cheap valuations, supportive government actions, and increased participation by both domestic and foreign investors (who are grossly underweight) should provide strong support for the market. In addition, a strong long-term factor supporting the market is that the stock market has significantly underperformed GDP growth (about 5% versus 14-15% for GDP over the last 20 an more years), and over time these two measures must converge – so the Chinese stock market has a lot of catching-up ahead of it – even while GDP growth slows down.
-A little publicised factor has been the upsurge in the Shanghai Index since July (see chart below) right after PBOC introduced the CNY 1 trillion of 'Pledged Supplementary Lending' (PSL) to China Development Bank - later dubbed "QE-Lite." This was followed by a $87 billion stimulus announced by the government in September and then the surprise rate cut by the PBOC recently. Government support for asset prices is a global phenomenon and as pointed out in last week’s letter, it is pointless to position against it. Having said that, the market has had a phenomenal run over the last few weeks and is probably due a pull back. With the final Fed meeting for the year on December 15 & 16, and the increasing likelihood of them dropping the “considerable time” language relating to a rate increase next year, we are likely to see some turbulence in global markets as we approach year-end. If that transpires, use it as a buying opportunity! ETFs referenced to the domestic market are ASHR-CSI 300 index-large cap A shares, ASHS –CSI 500 index-small cap A shares, or 3188.HK – CSI 300 index.
The recent surge in the Chinese stock market has allowed it to claim the title of the best performing major stock market in the world (+38.2% in US$ versus +34.5% for the Indian stock market). This has taken place despite continued widespread concerns (especially in the Western media) about a China hard landing and an imminent implosion of its property bubble. Morgan Stanley, recently publish two reports making the case for the commencement of secular bull market in China, which makes some interesting points and clarifies some prevailing misconceptions about the local stock market. To summarise:
-The China A-shares market has delivered superior dollar returns since 2000 : 12% per annum for Shenzhen-A and 8% per annum for Shanghai-A outperforming the U.S., Europe, Japan and Hong Kong (contrary to popular perceptions that the Chinese stock market has vastly underperformed-see chart below!).
-The capitalization of China’s A-share market has tripled since 2009 reaching $ 5 trillion, while the free float has quadrupled to $1.6 trillion (see chart below).
-Year-to-date until October 2014, the Chinese stock market (+8.0% Shanghai, +15.8% Shenzhen) has outperformed other domestic asset classes like real estate (+0.2%), bank deposits (+2.0%) and wealth management (i.e. trust) products (+5.9%).
-This is a reversal of the trend since 2008, when the stock market significantly underperformed (-12.4% Shanghai p.a., -4.3% Shenzhen p.a.) the real estate market (+14% p.a), bank deposits (+3.0% p.a.) and wealth management products (+8.8% p.a.). This drove private investors away from stocks and into housing and wealth management products.
-This reversal has been supported by the imposition of regulatory measures to cool the property market and impose restrictions on trust products, the government’s effort to support the stock market through official statements (in August and September), loosening requirements for new account openings and margin funding, and better access to foreign investors through expansion of QFII and RQFII and implementation of the MMA scheme.
-Since April 2014 China A shares have rallied and this has continued, even as the MSCI China and Hang Seng indices have corrected since September, following concerns about an economic slowdown in China and the demonstrations in Hong Kong (see chart below).
-The rally is the stock market has been enthusiastically embraced by local investors, as illustrated by the number of new account openings which have surged up in recent months (see chart below) and the daily trading volume on the stock exchanges which are a record high (see second chart below).
-To develop target prices for 2015, projections of the two key components – EPS growth and P/E multiple are required. EPS growth is assumed to be 10% which is well below the 15.4% historical average but closer to the average over the last few years. Noting that changes in the P/E multiples have been a more important driver of stock market returns than changes in EPS , P/E multiple scenarios are developed using historical analysis as well as using the S & P 500 and the Indian stock market as benchmarks.
-With the Shanghai-A currently trading at a P/E multiple of 14.2 x 12-month trailing earnings, which is a 35% discount to its 10-year average (see chart below), and assuming it reverts to its historical average of 21.8x , the upside for the stock market is 70% from current levels (as of December 5, ‘14).
- If the Shanghai-A multiple goes back to it 10-year low (i.e. a 1 std move below the historical average), then the downside is 28% from current levels.
-Assuming the Shanghai-A multiple moves higher by 1 std over its 10-year average then the upside is 165% from current levels.
- If the Shanghai-A multiple reaches its 2007 peak of 71.4x, then the upside is 450% from current levels.
-Assuming the Shanghai-A multiple reaches the S&P 500 level of 18.4x then the upside is 42% from now, and if it reaches the India-Nifty level of 21.8x its upside is 70% from now.
-Great research which makes a convincing bull case for Chinese stocks. The Chinese stock market does appear to be at the early stages of a secular bull market which could run until the end of this decade and perhaps even beyond. There will surely be cyclical bear markets along the way, but cheap valuations, supportive government actions, and increased participation by both domestic and foreign investors (who are grossly underweight) should provide strong support for the market. In addition, a strong long-term factor supporting the market is that the stock market has significantly underperformed GDP growth (about 5% versus 14-15% for GDP over the last 20 an more years), and over time these two measures must converge – so the Chinese stock market has a lot of catching-up ahead of it – even while GDP growth slows down.
-A little publicised factor has been the upsurge in the Shanghai Index since July (see chart below) right after PBOC introduced the CNY 1 trillion of 'Pledged Supplementary Lending' (PSL) to China Development Bank - later dubbed "QE-Lite." This was followed by a $87 billion stimulus announced by the government in September and then the surprise rate cut by the PBOC recently. Government support for asset prices is a global phenomenon and as pointed out in last week’s letter, it is pointless to position against it. Having said that, the market has had a phenomenal run over the last few weeks and is probably due a pull back. With the final Fed meeting for the year on December 15 & 16, and the increasing likelihood of them dropping the “considerable time” language relating to a rate increase next year, we are likely to see some turbulence in global markets as we approach year-end. If that transpires, use it as a buying opportunity! ETFs referenced to the domestic market are ASHR-CSI 300 index-large cap A shares, ASHS –CSI 500 index-small cap A shares, or 3188.HK – CSI 300 index.
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