Monday, February 02, 2015
There is an oft quoted incident, an anecdote, used to explain Chinese patience and focus on the long-run. It goes like this:
During Richard Nixon’s visit to China in February 1972, when asked the implications of the French revolution, premier Zhou Enlai famously said it was “too early to say.”
The explanation from an insider was that the premier was actually referring to turmoil in France in 1968 and not – as is commonly thought – to the more distant political upheaval of 1789.
Both conclusions are therefore insightful:
1) The Chinese are known for their long-term planning and vision;
2) The optics surrounding China are ambiguous at best and a total distortion at worst.
Given the backdrop, we are therefore puzzled and interested in the recent performance of China’s A-share market which began a dramatic rally on November 21st when Chinese authorities announced a surprise rate cut.
With potentially more easing to come and a liberalization of the A-shares market, permitting foreigners to buy stocks, local retail investors began a ‘panic buying’ spree with ‘liberal use of margin’.
The A-share market returned 54% in 2014, compared to 15% for the H-share market (Hong Kong Chinese listed stocks).
Why the puzzlement?
This note from Goldman Sachs summarizes the general view:
“We expect Chinese domestic economic conditions to remain relatively challenging. Ongoing headwinds from the housing market adjustment and shadow banking tightening will likely continue weighing on growth. Moreover, the government’s structural reform agenda adds risks to the outlook. […] Given this backdrop, we expect the government to lower the growth target to about 7% for next year in order to facilitate the transition to a lower but more sustainable growth path.”
Source: Goldman Sachs (December 2014).
Combine the above with a crashing commodity market, not an exaggeration, we ask how the Shanghai Stock Index can be rallying when the economic fundamentals are so poor? Here’s a headline from just this morning – unfortunately not a surprise:
China Minsheng Bank’s shares dropped yesterday as the president of the country’s largest private lender resigned on Saturday amid media reports that he had been taken away to assist mainland anti-graft investigators. – South China Morning Post
— Enough Hyperbole—
Let’s take a feather out of the Chinese cap and take look at the long view:
Figure 1 – Shanghai Stock Index 1990 – 2015
In the early 1990s the Shanghai Index commenced a monumental Bull Run which culminated in the 2007/8 scramble for Chinese stocks (remember reverse mergers into US corporate shells?). That secular Bull market saw the index appreciate by a staggering 5788% – which is not unlike other secular bull markets (Nasdaq +4039%; 1980 – 2000).
The subsequent crash in 2008 shaved off 73% of the Shanghai Index (Nasdaq top to bottom – 2000/02 was down 78%) and the index has been forming a base for the last 6 years.
Such patterns – secular bull rise, crash and a long base are quite common among markets that have undergone manias. We have cited the Nasdaq in the 90s but include the Nikkei in the 1980s and Gold in the 1970s as all having similar patterns.
The recent rise in the Shanghai index can therefore be placed into perspective:
– The opening of the A-shares market caused investors who were underweight to Buy the index;
– The Real Estate market in China is slowing , that game may be done for now, Chinese speculators are moving into stocks facilitated by the use of leverage;
– Rate reductions will have the same effect on Chinese Stocks as Western QE i.e. masking underlying economic weakness.
All said, valuations are low and ‘stimulus’ may lift the Chinese market yet. However ‘secular’ base formation patterns can take years to complete and it’s hard to imagine the Chinese economy reorienting toward a consumption based economy anytime soon (the central plan). Call us sceptics but we will sit out this Echo Boom!
P.S. the one way we would be comfortable investing in China today would through a long/short approach – our assessment is that there will be both winners and losers in this, the Chinese Century.
Chief Investment Officer
Advisory Services offered through Atlanta Capital Group.
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