China stock jitters look overdone
Just as Chinese stocks often rise without fundamental support, they are now tanking even though companies just had a better-than-expected earnings season.
Fears about a policy shift towards tighter liquidity are blamed for the 22 percent decline in the Shanghai market from its August peak. But those fears are largely overblown. Beijing might be talking about boosting domestic consumption, but structural reforms take time and there is little the authorities can do other than continuing to reinflate the economy in the short run.
There are encouraging signs that corporate profits — the fundamental basis for share prices — are on the turn.
Chinese companies’ earnings for the past quarter rose 36 percent compared with the previous three months, helped by strong results from banks and property firms. Companies also offered a more optimistic outlook, propelling a string of earnings upgrades.
The purchasing managers’ index, released on Tuesday, confirms that China’s manufacturing sector is keeping up its steady recovery.
Stocks are now trading at about 20 times forecast profits for next year. This is higher than the rest of the region, but Chinese companies enjoy higher growth rates: earnings are projected to grow by 20 per cent this year.
And compared with historical valuations, which range from the low teens to as much as 50 times earnings, current prices do not look excessive.
Premier Wen Jiabao this week tried to ease concerns when he said China’s economy was at a crucial juncture in its recovery and the government would not change its policy direction. But investors are taking their cue from the rising chorus of alarm sent by lower-level government officials, academics, and law-makers.
China’s parliament, usually a rubber-stamp organization, was unusually vocal in its late August session about the need to balance short-term relief with long-term development and structural reforms.
Meanwhile, the banking supervision commission has been cracking down on bank loans that make their way into stocks and property. In an effort to rein in excessive lending, it has also made it harder for banks to pass capital adequacy tests.
But even if Chinese banks stop lending in the second half — China’s largest bank ICBC even reduced its loan book in August — the swath of loans made in the first half will continue to work their way through the system during the rest of the year.
New lending in the first half amounted to an eye-popping 50 percent of gross domestic product on an annualized basis. Even if the ratio slumps to 10 percent in the second half, on average new loans as a percentage of GDP this year will still be double the 15 percent annual growth rate of the past three years.
In addition, as the flood of short-term bills — which banks accepted from companies to boost their lending volumes — start to mature, banks are diverting the cash into long-term loans tied to real projects that should help the economy in the coming months.
China’s monetary fine-tuning still looks marginal, even with July’s abrupt credit slowdown and a similarly subdued number expected for August. That’s because rising foreign capital inflows will offset some of the drop in bank credit.
Technical indicators also suggest the stock market has fallen too far. Chinese stocks had more than doubled between October and August and were ripe for a correction. Trading volumes have fallen substantially since the recent peak.
It is hard to call the bottom. But one thing that looks certain is that China’s companies and economy have proven to be stronger than many expected.
Lou Jiwei, chairman of China’s sovereign fund, said over the weekend that both China and America are dealing with past bubbles by creating new ones. Given how growth-minded Chinese policymakers are, it would be a mistake to bet on Beijing undermining the economy and the stock market by tightening too early.
— At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund. —