ARE FEARS ABOUT CHINA OVERBLOWN?
We’ve expressed concerns over the recent declines in Chinese shares mainly due to liquidity concerns (see here and here). China has been a superb leading indicator during the bear market of 2007 and the new bull market that began in China in late 2008. The recent dip in Chinese shares has sparked fears over potential global equity declines. JP Morgan, however, believes the fears over China are overblown:
We do expect loan growth to slow in 2H but mostly because of seasonal factors, as more loans come to maturity and few new projects start in winter, rather than policy tightening. Potential exclusion of subordinated debt in regulatory capital is unlikely to have a material impact on loan growth, as bigger banks have high tier-1 ratios, and as it will take time to implement such a measure.
Chinese policymakers look for stability rather than a correction, and have a diverse and effective set of tools to control supply and demand of both the equity and the property
markets. A stable domestic equity market is particularly important, as it is a precondition for the successful resumption of IPOs and the ambitious capital market reforms planned in the near term, such as the first red-chip listings in Shanghai and A-share listings of foreign companies.We believe that the Chinese authorities will take measures to put a floor under stock prices in the event of further correction. Indeed, the local press reported that the authorities had approved the issuance of new equity funds to channel investment funds into the stock market, and the central bank has kept open the market operation yield flat this week, after seven consecutive months of increases.
We think that fears about China are overblown; we see no reason to alter our strategy. We look for equity markets to rise 10-15% into year end. We see two catalysts for a continuation of the equity rally. First, economic data will likely continue to post positive surprises driven by developed economies. We track economic surprises using our Economic Activity Surprise Index, which remains firmly in the positive territory. Second, retail investors will likely start deploying a greater portion of their excess cash into equities rather than bonds, as slower declines in corporate bond yields will make the capital gains on their bond holdings
look less impressive than in the past months.
I don’t disagree with their big picture outlook, but I believe it’s foolish to ignore the recent market action in China considering the huge run we’ve had. This market gave early warning signals in both 2007 and 2008 and appears to be giving a similar warning signal now. I’d prefer to be a buyer of China and U.S. equities at lower levels….
Source: JPM
Interesting that China can “put a floor under stock prices”, and that “we track surprises”.
Does this mean that the Chinese market is manipulated, and that JP Morgan foresaw the recent U.S. market collapse or was it no surprise?
Note that today China announced that it would curtail overproduction of steel from some plants.
What possible faith does one put in markets of shares and commodities so controlled by the State?
Remember the opinions that Ireland was to become the centrpiece of Europe? where is it ranking now?
Trust the individual stock, not a market nor a country, and least of all a Government that still opposes capitalism, but must use it as an instrument of power gain.
One excellent blog to keep tabs on China:
http://mpettis.com/
Written by Michael Pettis, a professor of finance and US living and teaching in China.
His macro view is very perceptive. His view: is China is digging a deep hole for itself in attempting to keep the economy expanding by relying on and attempting to build up its export economy. As he sees it, the attempt to maintain the structural imbalance to prevent an economic downturn and unemployment in the near term comes at the expense of what’s needed in the long term: moving from an emphasis on exports to domestic consumption. The result: China will likely see many years of weak growth.
Hal,
No government can completely control the market. That’s like assuming that the police can control a riot. If the participants all rush for the exit the floodgates open as we saw last year. Of course, in a relatively rational, low volatility, low volume market like we have today it is easy to control price direction.
Don,
great link. thanks.
The piece reads as though they set out to dig up something to “explain” China in support of their existing thesis. (i.e., “buy stocks” aka “buy stocks so that we get paid”) They made sure to choose a reason which is both plausible, un-disprovable & “likely” to reverse anyway. (“If the Chinese authorities decide…”)
On the other hand, maybe this will be the first example in the history of the world where the government really can make the market go up — forever — with no consequences to currency, inflation, etc., etc.
Hi TPC, out of curiosity I am interested in some catalysts why seasonal factors this year would support the September outlook in the TPC report, in light of mostly better news, better economic news and expected better 3rd qt? China can be one if it continues to pull back. Thanks in advance.
VFS – No doubt about it. These guys are deeply entrenched in their recovery thesis. They have no choice but to defend it now….
Paul – The two primary seasonal trends that could work against the market this fall is housing and oil seasonality. Both tend to be weak in the 3rd quarter. From a risk management perspective after such a huge run, I am hesitant to own stocks up here….
RE: Paul, TPC … Adding to the seasonality will be the decline in US stimulus, muni and state legislatures trimming budgets or raising taxes, the start of the great CRE refi (attempted refi anyways), and by then another 6-10 months of China floating more trial balloons and incremental tightening. 2010Q1 will be very exciting.
RE: China
I’m not so sure a China decline will hurt badly. Has there been huge FDI recently? My recollection of some of Brad Setser’s last posts indicated that the foreign FDI since 2008Q3 (cumulative) has not been so great to put the world’s financial system in peril. Also, although the recent Chinese stimulus has been huge (at 30% of GDP in 6 months), chinese banking assets are only 110% of GDP. I think Japan in 1991-92, the total private sector debt was something like 250-300%. China’s imports have been declining for a while now, so investors should be “pricing that in”, but maybe most are just in denial. For, sure commodity and commodity emerging markets could sell off 30%, but I don’t think just because of China will we break new lows. BTW China debt, for investor may be a good thing … debt basically paid for the great 1982-2000 bull market, bubbles included. The problem is in China there is no clear indication of a corresponding ramp in PCE – just the bubbles.
I’d be cautious until 2010Q2. It should be much clearer that some of the above factors will be more visible and what government actions will be taken.
I find it interesting that JP Morgan doesn’t say anything about company earnings and doesn’t mention the current P/E ratio of the Chinese stock market. These are the kinds of things long-term investors need to know in order to judge whether the dividends from the companies are sufficient to justify their long-term investment or not.
Instead, JP Morgan talks about the willingness and the ability of the Chinese government to maintain high stock prices and prop up the stock market. Which is the kind of thing short-term speculators usually trade on. Short-term speculators don’t care about the intrinsic worth of the companies they buy. They only care about the price movements in the stock market, regardless of whether those prices are reasonable or not.
It’s this kind of speculation that drove Nasdaq all the way to 5000. And then Nasdaq crashed to 1100. And I think it’s a bit disingenuous of JP Morgan not to warn investors about the possibility of such a crash in China, when the Chinese government is no longer able to maintain very high P/E ratios in the Chinese stock market.
If Alan Greenspan couldn’t maintain Nasdaq at 5000 forever, then neither will the Chinese government be able to maintain high stock prices in China.
Nick, if you want P/E info, check out a China ETF as they usually compile basic info for their fund. Some index mutual funds also do it. But, its never really clear how the P/E is calculated (US GAAP?). You can sanity check the P/Es by looking at a few of the bellweathers that trade ADRs on NYSE or list in HK.
BTW … everything you say is true, that’s why understanding the big picture is helpful (its probably why you are reading TPC) … JPMorgan is just one small data point … understanding government actors, liquidity and fund flows is an important part of the “investing” process. Even if JPM gave you the P/E, it is one dimension, and along with the rest of our ADD/short-term results driven society, is becoming a decreasing part of the process. Think if you were buying a condo investment property: wouldn’t factors other than the current interest coverage ratio be important to you (large real-estate flipping activity? nearby plans for a shopping mall or factory? demographics? urban immigration? employers? owners vs. renters in the building? etc.) Would you believe the real-estate agent if he told you that “house prices increased last year at 20%, which means you’ll have 500% return in 3 years!”?
I’ve been waiting for Chinese authorities to stimulate the consumer sector. The problem is that selling goods to a developing nation – especially a factory powerhouse like China – is very difficult b/c the goods are ALREADY so cheap there. Despite all this talk of being brand conscious, the Chinese consumer is still notoriously price sensitive (aka cheapskates). Part of it’s cultural, the rest of it is practical since their cost of living is a lot lower than many Western nations.