Welcoming the return of the bulls

Stock markets are often considered to be synonymous with economic growth. But China has been an exception to this rule and is perhaps one of the few regions where one can find stock markets operating in splendid isolation, or in other words, not in tandem with economic growth.

So when reports of foreign institutional investors rebuilding their mainland stock portfolios first started doing the rounds in Hong Kong during November, they were treated with skepticism by most capital market experts. The doubts seemed justified as the markets were still bearish and there were no triggers for the bulls to return.

However, the initial disbelief soon gave way to renewed optimism as share prices firmed up sharply in the last two months and heralded the return of the bulls.

The benchmark Shanghai Composite Index exceeded the 2,400 level for the first time in nine months after rising for five consecutive days in early February. The index has risen about 23 percent from early December, when it was at a four-year low of 1949 points.

Even more encouraging were the reports that trading volumes on the last Wednesday of December alone had reached 135.6 billion yuan ($21.74 billion), almost four times the daily turnover in late November.

Sentiments improved further when robust macro-economic data dispelled the fears of an economic hard landing. The preliminary HSBC China Manufacturing Purchasing Managers Index, a gauge of the country’s manufacturing activity, rose to 51.9 in January from 51.5 in December, a 24-month high.

The impetus for the stock market rally came after the elusive small, individual investors started returning to the bourses. Bargain hunters were back in business and so were new entrants eager to grab a slice of the pie.

According to data provided by the China Securities Depository and Clearing Corp, as many as 117,600 new accounts were opened between Jan 14 and Jan 18. More than 12.6 million accounts were active in trading during the same period, a 13.4 percent growth from the previous week.

Even as the news of the market rally was yet to sink in, came reports that more than 800 companies were lining up plans to raise funds from the capital market through initial public offerings, secondary offerings and bond issues.

A healthy stock market was not only big news for the army of demoralized investors but also a boon to the many cash strapped enterprises, considering that easy credit was a thing of the past.

Despite the improved economic fundamentals, many experts still feel that the Chinese capital markets are still not ready for a massive revaluation. They contend that the latest earnings announcements have shown little improvement in the overall corporate earnings potential.

The average stock market price to earnings ratio (PE), has already adjusted upward to more than 12 times from about 10 times in the past few weeks. Further readjustment will depend on the projected performance of the major publicly traded enterprises in the key economic sectors, including property, finance, energy and telecommunications.

Growth factor

“We expect 2013 to be more stable and earnings growth to be the major driver of returns,” says Francis Chueng, head of China-Hong Kong strategy at CLSA, a Hong Kong-based brokerage and investment group.

Chueng says that market valuations are still below the long-run averages and hence “cheap”. The MSCI China index is trading at 9.4 times PE against 10 percent EPS growth with a 3.1 percent dividend yield. Return on equity is at a healthy 16 percent. “We have a 12 percent upside for MSCI China,” Chueng said in a recent research report.

“Faster reform progress is the key upside risk to market valuations,” explains a Goldman Sachs report. The bank remains overweight on insurance, retail and healthcare, and underweight in telecom and industrials.

“Economic recovery will continue. Macroeconomic policies are stable, and the PMI figures have been positive. The new round of urbanization will expand consumption and investment,” Jian Bijia and Chen Tong, analysts with Shenyin & Wanguo Securities said in a recent report.

But for now, many see it as a welcome break from the long spell of doom and gloom when as much as 4.3 trillion yuan evaporated from China’s A-share market in 2012. The bear grip also saw individual investors lose as much as 76,800 yuan each, the China Securities Journal said in a recent report.

But with the new leadership reiterating its commitment to stabilize the economy, push forward reforms and restructure the economy, and keep the markets open for foreign investors, there seems to be a sense of belief that the bulls are here to stay for some time.

 “The bear has gone,” says Chen Li, the head of China equity strategy at UBS Securities. He expects the A-share market to rise a further 20 percent this year.

“The dynamic price-to-earnings ratio for 2012 didn’t decline, an obvious signal that the bear market is ending. This year we may see a small bull market developing,” he says.

The Shanghai Composite Index is likely to post further gains this year, says a recent report published in the Securities Times.

Predicting the mainland stock market is often considered to be a tricky prospect as it is still young and immature. What’s more, trading is still dominated by the hundreds of thousands of small investors who are more influenced by “hearsay” and “heard” instinct rather than by the cool-headed study of market fundamentals.

In May 2007, profit margins had risen to more than 50 percent, while turnover had overtaken the levels seen in markets like UK and Japan. The Shanghai Composite Index hit a record high of 6,124 points on Oct 16, 2007.

All of that has since changed and the markets have been seeking lower levels, with the benchmark index falling below the 1,800 mark in 2008.

According to market experts, the root cause for the market declines has not been the external environment, but rather the inability of many listed companies — particularly the State-owned monopolies — to create shareholder value through innovative deployment of resources and to maintain sustainable growth in earnings, dividends and share prices.

A slump in external demand due to EU recession and the stuttering US economic recovery, and slowing domestic economic growth compounded problems for many Chinese companies last year, especially those in the manufacturing sector.

The Ministry of Industry and Information Technology also came out with guidelines last year for merging and restructuring big enterprises, in a bid to cut down on wasteful competition and improve earnings quality. About 900 listed companies, with a total market capitalization of 4 trillion yuan, were expected to have been included in the scheme.

Financing pipeline

Though there were several tightening measures last year, the government continued to maintain that the stock market was still the main funding channel or pipeline for enterprises’ financing.

With some companies shelving or putting on hold their listing plans, many others are expected to tap the domestic and overseas markets this year, due to the market rally.

For most of these companies, raising funds from the capital markets seems to be a much more sound proposition than borrowings from banks and other financial lenders.

Aggregate corporate debt has already exceeded 110 percent of the GDP, compared to the 90 percent ratio that is widely considered to be the upper limit or safety margin, says Yin Zhongli, a senior researcher at the Chinese Academy of Social Sciences.

This leaves little room for further leveraging by enterprises, Yin says, adding that any large-scale program to fuel economic growth with easy credit would backfire badly on the economy.

Due to these circumstances, “it is hard to understate the importance of a healthy stock market to the economy in general and the corporate sector in particular,” Yin says.

China’s gross domestic product (GDP) recorded a growth of 7.8 percent in 2012, a 13-year low and considerably lower than the 9.3 percent of 2011, according to data provided by the National Bureau of Statistics.

Although most of the economists were unanimous that the Chinese economy was facing downward pressure in 2012, with some even predicting a hard landing, the actual numbers indicated a better than anticipated performance.

The data also showed that consumer price index, the main gauge of inflation, was 2.6 percent, far lower than the government’s target ceiling of 4 percent.

The robust indicators also prompted many experts to issue optimistic outlooks for 2013.

“The big picture is that China has avoided a hard landing and has engineered a gradual rebound of its growth, from the second quarter of last year. The strong mandate received by the new leadership is expected to give a further boost to confidence,” says Dariusz Kowalczyk, senior economist with French retail banking group Credit Agricole.

Bank of Communications also released a report recently, expecting GDP growth for 2013 to be 8.5 percent, as long as the country is committed to economic reform. Supported by an investment stimulus as the new government takes over, along with a recovery in exports and stable growth in consumption, the economy will grow faster this year than in 2012, the report said.

The biggest challenge for policymakers would be to come out with steps to stimulate consumption, he says.

The National Bureau of Statistics had earlier indicated that consumption in 2012 had surpassed investment to become the largest contributor to the economy’s growth. Its contribution to GDP was 51.8 percent, opposed to 50.4 percent from capital investment, while the contribution from net exports was a negative 2.2 percent.

All of these show that rather than chasing an increasing speed of growth, the government is now more focused on rebalancing the economy and restructuring growth.

Stabilizing the market

Guo Shuqing, chairman of the China Securities Regulatory Commission, told a forum in January that China will increase quotas for so-called qualified foreign institutional investors and the local-currency denominated renminbi qualified foreign institutional investors (RQFII) schemes by tenfold.

“QFII has been stabilizing the market,” Guo explained. He said China wants large foreign institutions to put money into Chinese shares, “because these investors are more professional, they will also invest and keep the money in China for a long period of time”.

Foreign money currently accounts for just 1.5 percent of the overall mainland equity market. A tenfold increase to the QFII and the RQFII schemes would translate to about $400 billion in new funds flowing into the market, currently worth $38.5 billion, a very likely possibility, says Howhow Zhang, an analyst with the Shanghai-based boutique consultancy Z-Ben Advisors.

“If you look at other emerging markets such as India, Brazil and Russia, foreign participation is between 10 percent and 20 percent. In China, the current quota is tiny, so a tenfold increase is not an exaggeration,” he says.

The CSRC has in fact been pushing forward reforms in the stock market over the past years, including cutting trading taxes, urging companies to pay cash dividends and improving the delisting system.

The whole market has become more and more stabilized in the past three years. There has been a significant improvement in the valuation system. Although stocks for big companies are still undervalued, things are changing for the better, Guo says.

The writers can be contacted at xieyu@chinadaily.com.cn and gaochangxin@chinadaily.com.cn