China stock jitters look overdone

By Wei Gu
September 2, 2009

WeiGucrop.jpg– Wei Gu is a Reuters columnist. The opinions expressed are her own —

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. —

5 comments

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Excellent piece ! It ties in international finance with local corporate finance, shows the interrelationships between markets, stocks and bonds and legal aspects. The price-earnings is astounding, hopefully most of the earnings are free cash flows.

Posted by Casper Lab | Report as abusive

Government will be reluctant to “undermining” the economy as the money for reinvigorating the economy, stock markets and housing markets comes from government in its many forms. If it does undermine the markets then it would get its money back and banks will laded with bad debt. Sounds familiar…similar occurring about ten years ago.

Now that all loans have been invested in the markets volumes will drop off sharply and any noise about curbing excessive speculation then markets will dive.

Corporate earnings – can you believe them? Can they support their PE?

Posted by who | Report as abusive

It is not the first time to see Chinese stocks rising without support or diving without obvious pressure. As Chinese investors always say that they are actually ‘playing’ with stocks instead of ‘investing’ in stocks. Such turbulent-producing ideology may ‘play’ its leading role right now.

Posted by Haager Neder | Report as abusive

The Shanghai exchange is rising dramatically this morning by 5.5%, and the frequent high and low swings suggests an instability that is hard to evaluate, but it is clear the daily swings are not an accurate gauge of economic trends in China.

Posted by Harold R. Berk | Report as abusive

The Chinese economy is already flawed on 10 levels, atleast. With P/E’s like that and the present growth rate, it points to one outcome: cash flow problems. Speaking of which, the US bond book is astounding, the interest payments and close-out maturities must put a lot of pressure on the US cash flow, let alone the the subtle, calculated and callous reverse takeover of US public sector cash flow. Hopefully the US private sector won’t fall for that one in future with dividend payments and share buybacks.

Posted by Casper Lab | Report as abusive