Get ready for a three-year bull market
The Chinese mainland stock market may have suffered its biggest loss onMonday, but rebounded onWednesday. 2015 is set to be the first of what is likely to be a three-year bull run for Chinese equities.
We (at Nomura) have noted, “data on margin financing activities show that the year-end surge in A-shares was partially fuelled by borrowed money. This is a risk factor to consider as we head into the expected bull run of Chinese equities, given that such leverage positions are likely to be shaken out in occasional market pullbacks, which could aggravate declines in stock indices.” The latest sharp correction in A-shares serves as a fresh reminder that one is only good as one’s trade can last.
There will be further pullback and consolidation, led by financials, in the MSCI-China index during a good part of the first quarter of 2015. But such a correction is not inconsistent with our bullish outlook for three years.
A key piece of the puzzle of deleveraging local governments is for China to have a reasonably robust capital market over a number of years, so that it can fund the sales of various central and local government assets. This way central and local-level State-owned enterprises may inject quality assets into listed companies or new listed companies to monetize more of their hard assets and lower the leverage ratio by shoring up the asset side of their balance sheets.
This year, we anticipate more concrete evidence of reforms that truly benefit the Chinese public. For example, administrative reform is about putting government officials’ powers in the cage of rules, with increased processes, transparency and information symmetry. This means that instead of interfering and competing with the private sector, the government will leave more room for it to run businesses.
The hukou (house registration) and rural land reforms are about providing rural residents and migrant workers with more social benefits, partly funded by governments of coastal provinces that have benefited the most from migrant workers. These two reforms need to go hand-in-hand, but how exactly the costs of urbanization will be funded is still being debated.
Over the past decade, Chinese households have for the most part preferred physical property, not A-shares, to house their savings or investments. But over the past year or so, price expectations on physical property have dimmed because of rising supply and declining prices in many parts of the country. As such, physical property is more prevalently viewed as an alternative to savings where people are unlikely to lose money, rather than an investment to make money.
Besides, increased oversight on various shadow-banking products and the likely arrival of deposit insurance could also persuade Chinese households to invest in A-shares. To curb shadow banking, the State Council, or the cabinet, released Directive 43 on Oct 2, 2014. The directive is aimed at strengthening management of local government debt issuance and repayment through two important rules. Existing local government financial vehicle debts have been re-classified, and the government will guarantee payment of such debts only if they are classified as government debts. Going forward, local government debt issuance can only be in the form of bond issuance.
On deposit insurance, the central bank issued a draft onNov 30, 2014, proposing a coverage ceiling of 500,000 yuan ($80,423.34) per bank account for mainland depositors. Although theoretically, wealthy Chinese households may spread their savings over a few banks to gain full coverage of deposit insurance, the regulation could also persuade some to invest their money in A-shares to avoid having to deal with multiple banks.
Under China’s current approval-based initial public offering (IPO) system, companies go through a complicated process that involves multiple rounds of reviews over several years before getting the green light. Under this system, the regulator decides which company qualifies for IPO and how much can be raised, leading to rent seeking and inefficiency.
And given that China’s IPO system approves all A-share IPOs, it also puts pressure on the regulators to bail out retail investors. Among other factors, the outcome is the very low de-listing ratio of A-shares and plenty of speculative investment in reverse-mergers and asset injections that bring phantom stocks back to life. The author is head of China equity research at Nomura.