Get ready for a three-year bull mar­ket

China Daily (Canada) - - FRONT PAGE -

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.


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