A first warning?

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A bull market in China

This was the headline of a story in the Shanghai Securities News last Friday. The Chinese state publication reported in the article that there are more and more signs that there is a healthy bull market going on in China. For investors a clear signal that the Chinese government has backed the stock market. It resulted in the largest daily profit on the Chinese stock exchanges in five years. The CSI 300 index – consisting of the 300 largest listed companies on the Shanghai Stock Exchange and the Shenzhen Stock Exchange – rose 5.7 percent on Monday. Last night, the index rose by a further 0.5 percent. As a result, this year’s index stands at a profit of 14.68 percent.

Outperformance

With this price gain, the Chinese stock index beats the S&P 500 index by far. The Chinese technology index of Shenzhen also outperforms its American counterpart – the Nasdaq – with a 25 percent gain. The Nasdaq is expected to do 16 percent this year. As a result, the world’s second economy seems to be the first of the major economies to emerge from the corona. The CSI 300 rose by 15 percent last week alone. Incidentally, the index has not yet returned to the old top-level of 2015. At that time, the CSI reached 5353 points, still 14 percent higher than the current level.

Better purchasing managers

Stock market prices are partly supported by the gradually improving macro-economic figures. For example, the purchasing manager’s index for services – maintained by Caixin/Markit – rose to 58.4 last week. That was considerably higher than the low of 26.5 in February when the corona crisis still had China in its grip. A score above 50 indicates growth and 58.4 was even the highest in 10 years. Although the economy seems to be recovering, there is still room for caution. Unemployment, for instance, has been rising for five months and the Chinese consumption level is still far from the pre-crisis level. Even if corporate profits in China would rise by 10 percent in the second half of the year, they still remain below last year’s level.

Liquidity driven

So the economy is recovering, but not yet back to its old level. In the short term, the very generous monetary and fiscal policies of the Chinese authorities seem to be a major driving force behind this rally. This spring, for instance, the central bank significantly broadened its lending opportunities to support an economic recovery. Local Chinese banks were granted a licence to trade in equities and the Chinese private investor managed to find his way back to the stock market. But Hong Kong brokers also report increasing foreign interest in investing in Chinese equities.

Substantial A/H premium

So the rally seems to be driven not so much by increasing company profits, but by a wave of new liquidity. The number of outstanding margin requirements – required when investors buy shares with borrowed money – has risen to USD 164 billion, the highest level since January 2016. It is also noteworthy that A/H premium, the difference in price between the same companies listed in Hong Kong and on the mainland, has risen sharply over the past month. The same shares are on average 35% more expensive on the mainland stock exchanges than in Hong Kong, which is more accessible to large international investors.

A new bubble?

Is this a new Chinese bubble? Maybe there is. But Chinese stocks are a lot less expensive than their American counterparts. For Chinese equities, investors pay an average of 15 times the profit. In the United States, investors have to pay 21 times the profit. Moreover, the current rally in Chinese equities is not much compared to previous rallies. In 2015 share prices doubled in nine months. In the 2006-2007 bull market, the index even increased fivefold. But when state media start recommending buying shares, investors should be wary. It’s as if the Federal Reserve in the United States is saying it’s time to start buying shares. This morning, the index peaked at 4796 points, only to drop more than 2 percent at the close. A first warning?

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