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China's stock market: Is it the year of the bull again?

Forbes Forbes 22/11/2015 Ky Trang Ho

An investor observes stock market prices at a stock exchange hall in Jiangsu Province of China. (ChinaFotoPress via Getty Images)© Provided by Forbes An investor observes stock market prices at a stock exchange hall in Jiangsu Province of China. (ChinaFotoPress via Getty Images)

After falling apart like a knockoff Kate Spade handbag this summer, China’s stock market appears to be rebuilding itself. Is it finally the year of the bull again? It depends on which Chinese stock market.

A major China market index has technically entered a new bull market, which is defined as a 20% gain from a bear market low. Deutsche X-Trackers Harvest CSI 300 China A-Shares exchange-traded fund (ASHR), tracking the mainland China stock index, rallied a stunning 26% from its late summer low as of Friday.

ETFs tracking H-shares traded in Hong Kong, however, are still in a bear market. iShares FTSE/Xinhua China 25 Index ETF (FXI) is up just 15% from its trough. SPDR S&P China ETF (GXC) vaulted 19% from its third-quarter low while iShares MSCI China Index Fund (MCHI) popped 12%.

From a technical perspective, China ETFs are all still in a long-term downtrend because they have not broken above their 200-day moving averages. That’s a line in the sand that technical traders use to determine whether a stock is uptrending or downtrending. Volatility tends to increase below the 200-day moving average. The biggest moves up and down occur below that key level. A trend change cannot be confirmed until it breaks above that line.

Deutsche X-Trackers Harvest CSI 300 China A-Shares ETF (ASHR) Stock Chart

ASHR SharpCharts Workbench StockCharts.com: Here’s some insights about China’s stock market from experts at Columbia Threadneedle, T. Rowe Price and Bank of America Merrill Lynch. Weili Jasmine Huang, CFA, CPA, CPM, serves as director and senior portfolio manager of Columbia Greater China Fund (NGCAX) with $137 million in assets. The fund’s provider, Columbia Threadneedle Investments in Boston, has $471 billion in assets under management.© Provided by Forbes Here’s some insights about China’s stock market from experts at Columbia Threadneedle, T. Rowe Price and Bank of America Merrill Lynch. Weili Jasmine Huang, CFA, CPA, CPM, serves as director and senior portfolio manager of Columbia Greater China Fund (NGCAX) with $137 million in assets. The fund’s provider, Columbia Threadneedle Investments in Boston, has $471 billion in assets under management.

Here’s some insights about China’s stock market from experts at Columbia Threadneedle, T. Rowe Price and Bank of America Merrill Lynch.

Weili Jasmine Huang, CFA, CPA, CPM, serves as director and senior portfolio manager of Columbia Greater China Fund (NGCAX) with $137 million in assets. The fund’s provider, Columbia Threadneedle Investments in Boston, has $471 billion in assets under management.

Her fund is flat year to date, outperforming China region funds by about 2 percentage points, according to Morningstar. It’s returned nearly 1.6% annualized the past five years, beating its peers by 1 percentage point. It’s gained an average of 9.5% annually the past 15 years, eclipsing its peers by nearly 2 percentage points every year.

Huang explains why the recent rebound is more likely a countertrend rally and why China’s stock market could collapse again.

An Unsustainable Rebound

Ho: China’s stock market has rallied 20% from the summer low, technically starting a new bull market. Do you think this is a sustainable uptrend or a countertrend rally?

Huang: Actually only one of China’s two stock markets has rebounded 20% this year. That’s the market available mostly to Chinese investors and some institutional investors, known as the “A shares” market. The other stock market, called the “H shares” market, is based in Hong Kong, and is open to offshore investors. The H shares market has rebounded just 10% since this summer’s lows. While directionally, the performance is similar this year, the returns of these two markets can differ dramatically.

While both markets have rebounded, I view this as a counter trend, not a sustainable rally, especially for the onshore market. Both Chinese stock markets will continue to remain range-bound, as they’ve been for the past five years. I don’t see that changing anytime soon.

However, for onshore investors, the ride will be much bumpier as this market has been quite volatile as of late. For example, the A shares market was up 150%, then corrected by 40%, and is now up 20% from the lows.

Ho: What led the recent rebound?

Huang: After a long run-up the Chinese stock markets experienced a huge correction, largely in part to the Chinese government’s crackdown on margin trading. Additionally, the government purchased almost 10% of the market, in order to keep it from bottoming out. That leaves the government of China owning significant percentages of companies.

There’s no way they can exit these holdings in a short time frame, without defeating their original intent of supporting stock prices. However, it’s obvious that they need to unwind these positions as some point. This going to hang over the market like a dark cloud in the months and years to come.

China ETF Performance Compared With Major Global Benchmarks

NameTicker

%

Total Return

1 Month

% Total

Return

YTD

%

Total Return

12 Month

%

Total Return

3 Year


%

Total Return

5 Year

%

Total Return

10 Year

$mil

Fund Size

Total Assets

Guggenheim China Real Estate ETF TAO -0.81 -0.53 0.68 1.67 2.44 19.03
CSOP FTSE China A50 ETF AFTY 7.43 31.98
Deutsche X-trackers HrvstCSI500CHN A SC ASHS 10.62 34.02 38.15 37.65
Market Vectors® ChinaAMC A-Share ETF PEK 8.62 4.61 42.59 17.14 2.44 93
Guggenheim China Small Cap ETF HAO -1.06 -0.96 -2.68 7.34 -1.89 147.21
PowerShares Golden Dragon China ETF PGJ 9.04 13.46 3.56 21.61 4.39 9.81 177.86
Deutsche X-trackers Harvest CSI300 CHN A ASHR 6.72 2.07 39.36 556.36
SPDR® S&P China ETF GXC 0.34 -2.67 -0.03 6.18 1.45 918.19
iShares MSCI China MCHI -2.45 -4.86 0.59 4.2 1,892.18
iShares China Large-Cap FXI -3.94 -8.64 -0.36 3.37 -1.06 8.62 5,819.92
Vanguard FTSE Emerging Markets ETF VWO -3 -10.56 -14.18 -2.61 -3.11 4.62 36,799.26
iShares MSCI EAFE EFA 0.02 2.06 -1.44 7.87 4.27 3.54 58,834.10
SPDR® S&P 500 ETF SPY 2.55 2.95 3.68 16.8 13.93 7.41 178,841.62
Source: Morningstar

Ho: Is the uptrend sustainable without government stimulus?

Huang: To put it simply, no. But nothing in China is ever that simple. There are things working against the Chinese market that make further government stimulus necessary.

China’s GDP (gross domestic product) will continue to slow. This year, it’s reported to be at 7% growth. But the government has publicly lowered its target GDP growth to 6.5 % for the next five years. This could trend down to as low as 6%. And that’s going to put added pressure on the already precarious equity markets.

The other factor putting pressure on the markets is the Chinese currency, known as the renminbi. In recent months, the renminbi topped record highs, prompting the government to devalue it suddenly in August as RMB’s pegging to U.S. dollar made it appreciate substantially against its trade weighted currencies. The suddenness of this devaluation however had a backlash effect, causing not only the Chinese stock markets but also markets across the globe to reel.

Many feel that the renminbi remains too strong. The specter of further currency devaluations casts a shadow over the markets, sparking added uncertainty and volatility – two things stock investors dislike.

China Has More Economic Firepower Available

Ho: What else can the government do to stimulate growth if more is needed? Does it have more firepower?

Huang: Currently, the government is stimulating and supporting the economy in several ways. It’s loosened its monetary policy by lowering interest rates, reduced the cash reserve requirement for banks and it has started a program of physical spending by investing in infrastructure projects.

Consumption is playing an increasingly important role for the economy. The government is trying to get Chinese consumers to buy more. So they lowered the auto purchase tax by half, cut the down payment on mortgages from 30% to 20%. This helped stimulate the economy and the market to rebound.

We expect the Chinese government to continue attempts to stimulate the economy. But it won’t be for the purpose of driving growth. Rather, they are going to try to cushion the slowdown with their fiscal policies.

They can continue to cut interest rates and lower the reserve requirement ratio, known as the “RRR,” which is essentially the percentage of cash that banks need to have on deposit with the central bank. Both of these actions put more money into the economy.

The Chinese government also has room to do more physical spending, as the current fiscal budget deficit is just 2%. This spending helps to support the social welfare and consumption parts of the economy as well.

Investment Risks for China Now

Ho: What are the odds of the stock market collapsing again?

Huang: Macroeconomic trends are the key drivers for the performance of the equity markets. If we see growth decline, or unemployment levels climb, then those are worrisome signs for another potential collapse.

Right now, there is overcapacity on the mining, coal and energy sectors. If this overcapacity continues, which we feel is likely, there will be layoffs. Unemployed workers translate to lower consumption. If you’re not working, you’re not spending.

The Chinese currency is always a concern. If there were a subsequent, substantial currency devaluation then we’re going to see a repeat of what happened in August, when the Chinese market fell precipitously.

Lastly, the fact that Chinese government now holds a big stake of the domestic, onshore market remains a troubling factor. At some point, they will begin to sell and that will put downward pressure on prices.

Ho: What risks must investors consider now?

Huang: Our expectation is that China’s economy will slow as it undertakes a major transformation from an industrial, manufacturing economy to a consumption-driven, service-focused market. This transition has already started. But it’s going to take years for it to come to fruition. While there will be pain — there is in every transition – this change is necessary for China to have a sustainable economic model in the years to come.

Consumption is now more than 50% of China’s GDP and the service sector is playing an increasingly important role in driving employment and income growth for China’s families.

In order for China to move from the “Old Economy” (investment driven) to the “New Economy” (consumption and services driven), the government needs to continue to reform. They need to close down and restructure plants operating in overcapacity industries such as energy and mining. They need to support the new economy by allowing more privatization of companies. Additionally, they need to provide more of a social safety net to the Chinese people.

As the economy begins to morph, new, innovative players have risen to the forefront. These companies that take advantage of economic and demographic changes, while contending with environment and social issues, will survive and flourish. Hence, we favor sectors such as information technology, healthcare and the like.

China ETFs and Fundamentals Compared With Major Global Benchmarks

NameTicker
$mil

Fund Size

Total Assets

%

Expense

Ratio

Price/

Book

TTM

Price/

Earnings

Forward

Price/

Sales

% Proj

EPS Growth

5 Year

%

Dividend

Yield TTM

Guggenheim China Real Estate ETF TAO 19.03 0.71 0.57 9.86 1.49 9.5 2.6
CSOP FTSE China A50 ETF AFTY 31.98 0.99 0 0
Deutsche X-trackers HrvstCSI500CHN A SC ASHS 37.65 0.8 3.05 28.82 1.65 25.28 0.09
Market Vectors® ChinaAMC A-Share ETF PEK 93 0.72 1.97 13.44 1.35 10.91 0
Guggenheim China Small Cap ETF HAO 147.21 0.76 0.98 10.55 0.71 15.57 2.28
PowerShares Golden Dragon China ETF PGJ 177.86 0.7 0 0 0.66
Deutsche X-trackers Harvest CSI300 CHN A ASHR 556.36 0.8 1.72 12.05 1.19 10.99 0.28
SPDR® S&P China ETF GXC 918.19 0.59 1.29 10.2 1.03 10.9 1.68
iShares MSCI China MCHI 1,892.18 0.62 1.39 10.27 1.17 10.31 2.21
iShares China Large-Cap FXI 5,819.92 0.74 1.34 9.58 1.14 9.34 1.96
Vanguard FTSE Emerging Markets ETF VWO 36,799.26 0.15 1.55 12.44 1.15 11.46 3.09
iShares MSCI EAFE EFA 58,834.10 0.33 1.62 16 1.01 8.7 2.76
SPDR® S&P 500 ETF SPY 178,841.62 0.09 2.4 18.53 1.74 9.84 1.99
Source: Morningstar

New Investment Opportunities

Strategists at other major T. Rowe Price are more optimistic.

China’s economic woes are well known but opportunities do exist, especially in technology, consumption, and services, as well as in some state-owned companies that are undergoing structural reforms, say strategists at T. Rowe Price.

“The turbulence we have seen recently in Asian markets is not a crisis in the making,” Anh Lu, portfolio manager of T. Rowe Price New Asia Fund (PRASX) with $2.77 billion under management, said in a 2016 outlook. “Reforms are happening, albeit slowly, valuations are supportive of future potential gains, and the corporate earnings outlook is generally improving.”

“In addition, much of Asia benefits from falling commodity prices,” Lu added. “But challenges remain in the form of weak export demand, high debt levels, especially in China, and corporate return-on-equity rates that need to improve. We see neither boom nor doom in Asia next year and believe that markets in the region provide plenty of opportunities with reasonable valuations.”

Lu’s fund lost 5% year to date, underperforming its peers in Morningstar’s Asia Pacific fund category by 8 percentage points. It’s returned an average annualized 2.4% the past three years, lagging its peers by 5 percentage points. But over a 15-year period, it’s outpaced its group by 5 percentage points annually. It’s returned an average of 10% annually over that period.

Analysts at Bank of America Merrill Lynch say they were surprised by what they saw during an early November visit to China given the negative data coming out of the country.

“Our impression is that the industrial environment in China has stabilized going into the year-end,” BofA ML analysts wrote in report Nov. 8. “The overall outlook for industrial activity related to China into 2016 remains subdued, with the exception of growth areas like consumer, healthcare or secular growth stories in the industrial space like turbo penetration in passenger cars or passenger air traffic growth.”

“The automotive market is a notable exception, now seen recovering into 2016 on the back of a tax cut for smaller vehicles. We expect limited visibility on industrial trends until after the Chinese New Year, with supporting data only available starting in the first quarter 2016 reporting season.”

They believe the market depends on China’s ability to implement economic reforms.

“The bear case rests on the potential instability of China’s financial system and the government remaining preoccupied with consolidating power,” BofA ML analysts wrote. “The bulls argue that the power consolidation will pave the way for significant reforms. And the industrial slowdown is being offset by rapid growth in the services segment.”

China Mutual Fund Flows

China mutual funds have experienced $27.6 billion in net outflows globally, about 10% of assets, year to date as of Nov. 20, according to Jefferies. Hong Kong funds shed a net $1.1 billion or 2% of assets.

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