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Page | 1 | PHILLIP SECURITIES RESEARCH (SINGAPORE) MCI (P) 022/11/2014 Ref. No.: SG2015_0190
CHINA/HK
A Self-fulfilling Prophecy
MACRO | ECONOMY | EQUITY MARKET
16 July 2015
Downgraded China macro outlook to Neutral from Positive. We expect the risk-off
selling to diminish in near term on the back of macro stabilization. Key challenge the government faces is how to revive retail investors’ confidence amid
reforms and economy slowdown. Concerns that the “rescue package” could complicate reform progress. An aggressive
intervention could even cost a setback to the reforms. Risks remain: Weak global demand, overcapacity issues, high levels of local government
debt, and slowing growth in investment and hence sluggish credit growth. Maintain Positive rating for Hong Kong on opportunities and positive prospects brought
forth by reforms and opening-up policies in mainland. H-Shares appear to be more attractive than A-Shares in terms of valuation as well as
fundamentals. Executive Summary Expect a moderate rebound in 2H2015. Economic fundamentals should improve
towards year-end, as impacts from the reforms and growth supportive measures rolled out start to kick in.
The central bank is likely to cut the benchmark interest rate or RRR, or both, again this year to spur credit growth.
Valuations have now corrected for the Chinese stocks. The sell-off presents an entry point for investors to enter the market. SHCOMP’s current valuation (P/E at 19.4x) has returned to below its 10-year
average P/E of 20x. Forward P/E would average to 15.8x based on a 17.6% consensus forecast earnings growth for the year (with downside bias on lower corporate earnings, productivity and growth in near term).
Catalysts for Hong Kong stock Cheaper as compared to its mainland counterparts and other markets. HSI is
currently trading at 10.4x its earnings, far from its long-term average P/E of 13x. The impending SZ-HK Stock Connect, the QDII2 scheme and the Mutual
Recognition of Funds (MRF) would trigger more southbound inflows, boost the demand and benefit H-Shares.
Investment Actions Unit Trusts Fidelity Greater China Schroder Greater China Fidelity China Focus HSBC GIF Chinese Equity ETFs db x-trackers MSCI China TRN Index 1C (LG9.SGX) db x-trackers CSI300 Index ETF 1D (KT4.SGX) ChinaAMC CSI 300 ETF (3188.HK/83188.HK) db x-trackers FTSE China 50 (DR) 1C (HD8.SGX) iShares FTSE A50 China (2823.HK) CSOP FTSE China A50 ETF (2822.HK/82822.HK) iShares China Large-Cap (FXI.US) Lyxor HSI 10US$ (A9B.SG) Tracker Fund of Hong Kong ETF (2800.HK) Hang Seng ETF (2833.HK)
Soh Lin Sin (+65 6531 1516)
Page | 2 | PHILLIP SECURITIES RESEARCH (SINGAPORE)
CHINA/HK
MACRO
What you should know China experienced an abnormal growth and volatility in a very short time frame in recent months. Since mid-2014, the benchmark index, SHCOMP, rose about 150% to its peak at 5,166.4 on 12 June 2015. The meltdown vaporized about $3tn from China’s stock market. Here we sum up what happened since 2014, and the list of events that powered the self-fulfilling prophecy in China. What fueled the rally? Despite persistent weakness in macro fundamentals and concerns of hard
landing in the Chinese economy amid stepped up reforms, SHCOMP rallied 150% since mid-2014.
Liquidity and leverage, rather than fundamentals, drove the sharp market rally. Optimism on reforms, especially after the debut of SH-HK Stock Connect, easy access to margin financing and speculation on more stimulus measures supported the upward trajectory.
Who burst the bubble? What the exact trigger that started the downward spiral was is difficult to identify, but here’s some of our thoughts. 1. Better economy prospects – wait, what? As the property market slowdown is one of the main factors that weighed on the
economy, Chinese authorities have since eased mortgage policies and loosened property restrictions to prop up growth. The property market picked up in May, but a sharp rebound in the near term is unlikely.
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China New Home Price IndexSource: CEIC, PSR est.
%y-y
%m-m (RHS)
The gradual recovery in the property market should help to support the Chinese economy. We should see fixed asset investments (FAI), manufacturing sector and industrial production to pick up towards year-end.
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05 06 07 08 09 10 11 12 13 14 15
China Fixed Asset Investment (Source: CEIC)
%y-y 3mma
%y-y 12mma
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MACRO
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05 06 07 08 09 10 11 12 13 14 15
China Val. Add of Ind. Prod.(Source: CEIC) %y-y 3mma
%y-y 12mma
Cross-border infrastructure projects, arising from the “Belt and Road” initiative (BRI), should reduce overcapacity issues (heavy constructions should increase demand for materials) and boost FDI.
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05 06 07 08 09 10 11 12 13 14 15
Thousands
%y-y 12mma
%y-y
FDI (12mrs)
China FDI Utilized (Source: CEIC, PSR est.)
Notwithstanding the above, retail sales are pointing to improvement after being hit by the anti-graft campaign.
10%
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05 06 07 08 09 10 11 12 13 14 15
China Retail Sales of Consumer Goods(Source: CEIC)
%y-y 3mma
%y-y 12mma
However, in China’s case, good data does not necessary mean good news to investors. In fact, investors started to taper their expectations for more stimulus measures when macro indicators started to turn around.
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New restrictions on margin trading (the government’s effort to curb speculations and enhance risk management) and concerns about the overvaluation of many stocks have forced mainland investors — mostly individual retail traders — to cash out.
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Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15
%y-o-y Market Value ofSecurities Used as Margin
Source: CSFC, PSR est.
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Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15
%y-y Margin Purchase
%y-y Short Selling
Source: CSFC, PSR est.
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Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15
%y-y Newly Opened Accounts
%y-y Number of Margin Accounts
Source: CSFC, PSR est.
Page | 5 | PHILLIP SECURITIES RESEARCH (SINGAPORE)
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2. Government intervention In attempts to prevent market fallout and to avert systemic risk after the both
the Shanghai and Shenzhen indices have lost more than a third of their value, Chinese authorities have unveiled market-boosting measures almost every night in early July.
Objective Rescue Measures Remarks
To ease liquidity worries
Cut policy rate Lowered the required reserve
ratio (RRR) Eased regulations and rules on
margin financing
Real lending rate is still high. Subdued inflation and weak economy growth provide scope for monetary easing.
The reversal in its previous attempts of tightening on margin finance could send its reform progress back to square one.
To prevent further drainage
Extended trading halt to more than 50% of all listed companies on China’s the Shanghai and Shenzhen markets
Barred 111 major state-owned enterprises (SOEs) and major shareholders of non-SOE listed companies from selling shares
Suspended initial public offerings (IPOs)
The suspension of trading for a growing number of companies may have also exacerbated the liquidation of other stocks that are still available for trading. It could also adversely affect the tracking of ETFs worldwide.
The directive to ban sales may lead to some foreign investors shelving their plans to divest their interests in mainland companies.
Suspension of IPOs is a regular tactic used to limit supply increases, but would be a setback to the IPO/domestic capital market reform.
To curb speculative tradings
Restricted bearish bets via stock-index futures
Launched a crackdown targeted at malicious short selling on stocks and indexes
To stabilize market
Encouraged financial firms to invest into equities market
The joint statement by securities companies to buy CNY 120bn worth of stocks
The continuous equity market interventions are signs of desperation by the
country’s leadership. The raft of rescue measures taken by government backfired: instead of having desired effect in stabilizing sentiment, it stoked fears and the market went deeper into panic mode.
Notwithstanding that, some of the measures could create distortions in the market, for example: Financial institutions, supported by the government, are now the key line of
defense to support broader equity indices by purchasing blue-chip stocks – either directly or through purchases of exchange traded funds (ETFs) that track only large stocks
The China Securities Finance Corp (CSFC), the government-backed margin finance agency, has become a vehicle for government to inject liquidity into the market
3. Herd mentality amid panic attack The Chinese stock market is dominated by retail investors – about 80% of
investors are the less sophisticated investors. Retail investors are naturally enthused by momentum. They got jittery seeing the pace of the fall off, inducing them to bail and sped up the drop.
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4. Profit-taking After a good rally (the market is up 150% on a year ago), some long-term
investors are cutting their exposure – cashing out profits and getting out of the market as some stocks became overvalued.
5. External factors, e.g. Grexit and weak global demand, fueled the plunge
What is the impact? If the stock market resumes its previous nose-dive, it could jeopardize the whole
economy’s growth – adding to the concerns of hard landing. The spillover effect of China’s share market volatility could also pose contagion risk globally. Potential ripple effect on China’s economic growth, corporate earnings, and
financial stability. The systemic financial risk may spread to the real economy and other asset markets, such as property sector, and the FX/debt market.
Extending to its Asian counterparts, especially with the Hong Kong equity market feeling the most pain of a spillover effect. Stocks in Hong Kong suffered their worst trading session since the global financial crisis of 2008 despite having stronger macro fundamentals compared to its mainland counterpart.
China’s woes have sent a number of commodities tumbling to multiyear lows. As one of the world’s largest consumers of oil and metals, China’s share market volatility could have broad repercussions, weighing on demand for goods and services broadly, and pinching global companies that are closely tied to Chinese growth.
What to expect? Stock market regained ground in 9
th July 2015. Year-to-date gives a near 20%
positive return while 1-year return logged around 90% gain. If market stabilizes, we will not see such a dramatic drop in the near term –
individual participation should be more rational than before and likely with a slower participation pace.
If investors continue to sell off on low confidence, then it may spill over to the global market and hamper economy growth.
The key challenge the government faces is how to revive retail investors’ confidence while grappling with the repercussion of their supportive measures amid reforms and economy slowdown. Rolling out more supportive measures would further complicate their reform
progress. An aggressive intervention could even cost a setback to reforms. A more diversified investor base is much needed – especially participation of
the more sophisticated investors and institutional investors. The combination of economic slowdown and a benign inflation outlook provide
scope for the central bank to ease monetary policy further. Consumer inflation remains benign at below 2%: reflecting weak domestic
demand Factory gate prices still face deflationary pressure, signaling that
overcapacity issue remains New loan growth remains subdued: real lending rate is still high despite
several rounds of rate cuts
Page | 7 | PHILLIP SECURITIES RESEARCH (SINGAPORE)
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5%
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15%
05 06 07 08 09 10 11 12 13 14 15
CHINA GDP(Source: CEIC, PSR est.)
%q-q saar
%y-y full year
%y-y Real
Against this backdrop, we expect another round of interest rate cuts, or RRR cut (RRR is still high at around 18.5%), or both, to jumpstart the credit cycle.
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05 06 07 08 09 10 11 12 13 14 15
CHINA CPI/BLACK, PPI/BLUE(Source: CEIC)
%y-y
%y-y
Page | 8 | PHILLIP SECURITIES RESEARCH (SINGAPORE)
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MACRO
Conclusion Downgraded China’s investment outlook to ‘Neutral’ from ‘Positive’ We expect the risk-off selling to diminish in near term on the back of macro
stabilization. Economic fundamentals should improve towards year-end, as reforms and growth supportive measures rolled out earlier trickle down the real economy.
The rescue package, albeit may be temporal, could distort the market and cause setback to the reform progress.
Undoubtedly, China has a long way to go. However, we maintain our conviction on China’s long-term development. More reform progress should also help to attract more foreign participation in the China stock market. A more diversified investor base should help to reduce volatility.
Factors to monitor for a potential re-rating More pro-growth stimulus measures Reforms development * Note: We have changed our terminology for the macro-outlook rating metric:
New Rating Terms
Old Rating Terms
Denotation
Positive Overweight (OW)
Securities are generally expected to (i) increase in value in the near future; or (ii) outperform securities of other market. Investors could consider increasing weightage of relevant securities holdings in their portfolio.
Stable or Neutral
Neutral-weight (NW)
Securities are generally expected to (i) neither increase nor decrease in value in the
near future; or (ii) perform at the same pace with securities of
other market. Investor could consider maintaining weightage of relevant securities holdings in their portfolio, or undertake an option strategy that may profit despite the lack of movement in the underlying security.
Negative Underweight (UW)
Securities are generally expected to (i) decrease in value in the near future; or (ii) underperform securities of other market. Investors could consider reducing weightage of relevant securities holdings in their portfolio.
Page | 9 | PHILLIP SECURITIES RESEARCH (SINGAPORE)
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Equity Markets A-Shares valuations corrected
SHCOMP Index
6
12
18
24
30
36
42
48
05 06 07 08 09 10 11 12 13 14 15
Source: Bloomberg
T4Q P/E
F4Q P/E
-0.5 sd
+0.5 sd
LT PE avg
0
50
100
150
200
250
300
-50%
0%
50%
100%
05 06 07 08 09 10 11 12 13 14 15
China T12M EPS (Source: Bloomberg)
EPS %y-y EPS
0
1
2
3
4
5
6
7
8
05 06 07 08 09 10 11 12 13 14 15
Source: Bloomberg
P / B
+1 sd
-1 sd
LT PB avg
Page | 10 | PHILLIP SECURITIES RESEARCH (SINGAPORE)
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MACRO
Buying H-Shares We are still of the view that H-Shares offer a better opportunity (in terms of
valuations and fundamentals) as compared to A-Shares. Catalysts
The impending SZ-HK Stock Connect (expected to come online in 2H15) offers arbitrage opportunities for AH investors. The dual-listed stocks should start to converge (with the SH-HK Stock Connect setting a precedence). Investors could look into stocks with scarcity value and AH discounts.
Also, the QDII2 scheme and the Mutual Recognition of Funds (MRF) should trigger more southbound inflows, boost the demand and benefit H-Shares.
Hang Seng Index
5
10
15
20
25
05 06 07 08 09 10 11 12 13 14 15
Source: Bloomberg
T4Q P/E
Fwd 4Q P/E
+1 std. dev.
-1 std. dev.
10-yr avg P/E
1.0
1.5
2.0
2.5
3.0
3.5
05 06 07 08 09 10 11 12 13 14 15
Source: Bloomberg
P / B
+1 std. dev.
-1 std. dev.
10-yr avg P/B
Hang Seng China AH Premium Index
80
100
120
140
160
180
200
06 07 08 09 10 11 12 13 14 15
Source: Bloomberg
Hang Seng China AH Premium Index
52 weeks avg
-1 sd
+1 sd
LT avg
-1 sd
+1 sd
LT avg
Page | 11 | PHILLIP SECURITIES RESEARCH (SINGAPORE)
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MACRO
Appendix A: Timeline of Significant Events
Page | 12 | PHILLIP SECURITIES RESEARCH (SINGAPORE)
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MACRO
Date Significant Event(s)
21 Nov'14 PBoC cuts rates by 40bps
28 Dec'14 PBoC changes rules on loan deposit requirements to ease liquidity pressure -
giving banks more room to lend
19 Jan'15 SH market corrects close to 8% as regulators clamp down on margin lending
22 Jan'15 PBoC reintroduced reverse repos to meet cash demand ahead of Chinese New
Year
4 Feb'15 PBoC cuts reserve requirement ratio (RRR) by 50bps
28 Feb'15 PBoC cuts rates by 25bps
5 Mar'15 Premier Li Keqiang cuts China's GDP gorwth target from 7.5% to 7%
8 Mar'15 Ministry of Finance announces trillion yuan local government debt swap
19 Apr'15 PBoC cuts the RRR by 100bps
10 May'15 PBoC cuts rates by 25bps
10 Jun'15 Ministry of Finance expands local government debt swap to 2 trillion
MSCI stops short of including China A-Shares in global benchmark but
market has priced in the inclusion
12 Jun'15 Peaked at 5,166.4
24 Jun'15 PBoC scraps loan deposit ratio cap
27 Jun'15 PBoC cut rate by 25bps and lowered RRR (for selected banks) by 50bps
29 Jun'15 Up to 30% of USD 570bn pension fund likely to be invested in stock market
30 Jun'15 Easing of regulations and rules on margin financing
13 major private fund managers jointly voiced bullish views on A-Shares
1 Jul'15
Further easing of regulations and rules on margin financing. CSRC
announced new rules on margin financing and removes the mandatory level
for margin calls and mandatory liquidation
Increase of shareholding by listed companies: major shareholders of 182 A-
Shares listed companies have increased their shareholdings, shares
repurchase by A-Shares listed companies
2 Jul'15
The SSE, SZE and China Securities Depository and Clearing Corporation Ltd
announced reductions to A-Share trading transaction fees, effective Aug 1
3 Jul'15
CSRC increased registered capital for CSFC from RMB 24bn to RMB 100bn
CSRC announced that the number of IPOs and the amount of capital to be
raised through IPOs will be significantly reduced subsequently
4 Jul'15
Major brokers launch market stabilization fund of no less than RMB 120bn:
21 securities brokers announced plans to buy blue chip ETFs
25 major Chinese mutual funds to invest in equity funds managed by
themselves
CSRC suspended 28 IPOs that have been scheduled for subscription in July
5 Jul'15
Central Huijin reportedly purchased A-Shares ETFs
PBoC to provide liquidity support for CSFC to raise funding to stabilize the
market
CSRC announcement of tighter measures against market manipulation and
rumor distribution activities
6 Jul'15 Daily trading limit set for CSI 500 futures: investors can only buy up to 1,200 lots of
CSI 500 index future contract for long/short positions
8 Jul'15
CSRC bans shares sales by major investors for 6 months
Trading suspended in more than 1,000 stocks
9 Jul'15 CBRC tells banks to roll over loans back by equity collateral
Page | 13 | PHILLIP SECURITIES RESEARCH (SINGAPORE)
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Contact Information (Singapore Research Team) Management
Chan Wai Chee (CEO, Research - Special Opportunities)
[email protected] Research Operations Officer Mohamed Ghazali [email protected]
Macro | Equities Market Analyst | Equities Soh Lin Sin [email protected] Kenneth Koh [email protected] Bakhteyar Osama
Transport & Logistics REITs Richard Leow, CFTe
[email protected] Dehong Tan [email protected]
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