Chinese Equity A Bubble In The Making?

Well, that should not even be a question, its a fact. The question should be for how long. Just because a market is considered expensive, does not mean one should get out immediately. It will be a tug of war. A bubble is usually because there is a concentration of liquidity and a flush of liquidity, as explained numerous times in this blog. Yesterday saw China markets doing a whipsaw, falling dramatically but still regaining some ground back. That is a prime example of a very strong momentum market. It will be volatile but the investors and players are not ready to leave the playground yet. Hence on rumours of possible tightening by the central bank, the markets will take that as an excuse to take profit and take some chips off the table. I don't think the China markets and HK market included will be paralysed so soon. Judging from the liquidity exhibited in recent IPOs in HK and Shanghai, this rally has some legs. Still, one has to react swiftly, in and out, its a traders' market not a buy and hold market.

After falling 70% from its peak in late 2007, the Shanghai Composite Index is up more than 80% off its low in November 2008 and 70% for the year. China's total market cap has risen 122% in 2009 to more than 10 trillion yuan. Valuations have more than doubled from their lows in November, but are still well below their peak in January 2008. In July IPOs resumed after new rule changes were put in place.


• July 10: The Shanghai Composite Index is up 70% in 2009, after falling 70% from the peak in late 2007. The Shenzhen index is up 87% in 2009. Trading on the first IPOs in nine months was halted after they jumped more than 20% from their opening price. The Chinese equity markets have rebounded on the back of the fiscal stimulus, expectations of a recovery in property markets and signs of improvement in domestic demand have given markets another boost
• Some of the new loans extended during the Q1 surge in bank lending likely found their way into the equity market as investors seek better return on assets, this could imply that the lending surge is not being invested in sectors that will boost growth- and that stock market gains are vulnerable especially given that Chinese equity returns have become more correlated with global trends
• China and other emerging markets have outperformed developed markets in 2009, suggesting that investors believe emerging markets have "decoupled" again. Another view is that emerging markets underperformed on the way down, and are over-performing on the way up—suggesting not decoupling but rather that they are performing like high-beta assets
  

Are Higher Valuations Sustainable?
• Stocks on the Shanghai Index traded at 28.1 times earnings in early June 2009, more than double the 12.9 factor they traded at in Nov, but below their peak in Jan 2008 at 50 times earnings
  
• Citi: Ample liquidity continues to push up asset prices. After strong lending growth through April, the market expects a slowdown in May/June. But May’s volume could be close to April’s (RMB591.8b), and June could see further growth, thanks to the non-seasonal pick-up in economic activities for the summer months
• DBS: State-owned enterprises' profits track exports more closely than GDP growth, suggesting that profits will remain under stress even as domestic conditions improve. Sticky wages and increasing commodity input prices increase the pressure from the cost side. Further, because inflation is likely to pick up before corporate profits, SOE's will likely face tighter credit conditions before their balance sheets improve
• Policy responses have boosted confidence and prevented further contractions of consumption and investment. Property, retail, and auto sales are healthy in volume terms, even if prices remain deflationary. The real impact of the stimulus will take time to filter through the economy and will show up in H2 2009
• The Chinese equity market continues to be speculative because hedging tools are limited (deterring institutional investors) information on the companies is sparse. Level of government meddling in the market makes true transparency difficult Many retail investors (who led the boom in 2007) retreated to demand deposits
• After a surge of IPOs in 07-08, there have been no new issues since Sept 08, when regulators feared new supply could further damage existing shares. The China Securities Regulatory Commission issued new regulations for listings on June 11 and has taken legal actions intended to ensure that Chinese markets are less prone to manipulation; IPOs are expected to resume soon
  
• New listings and release of block shares could drain funds from existing shares, threatening this year’s gains. The rule changes are intended to increase access for retail investors to IPOs, and limit the valuation surges that followed flotations in 07-08
• In an apparent attempt to reduce market volatility as new IPOs come online, the government is requiring that SOEs that have listed since 2005 transfer 10% of their shares to the social security fund, which will be subject to a 3-year lock-up period
• In 2007, regulations intended to deflate Chinese equity markets were implemented (stamp tax raised from 0.1% to 0.3% in May 07), these were mostly reversed in 2008 when markets fell sharply (stamp tax repealed completely in Sept 08). In an attempt to boost existing shares, IPOs were suspended in Sept 08
  
• The average daily volume on the Shanghai exchange has more than doubled to 13.6bn yuan in May 2009 from a low of 4.4bn yuan in Aug 2008
  

Sectoral Outlook
• Citi: Consumer-facing sectors could benefit from policy shifts that would help boost domestic consumption. Auto sector profits trail sales growth, banking sector profits down y/y but show q/q momentum, cement and food/beverage sectors should outperform, and insurance sector looks positive
• UOB: A pick-up in demand in H2 2009 should benefit energy producers. Dropping property inventories and the massive reduction in equity ratio requirement (20% from 35%) for new ordinary residential projects will boost the property sector, in turn boosting demand for steel and aluminum, as well as energy
• Planned massive infrastructure spending on the mobile network over the next 3 years should boost the telecommunications sector. Export-oriented industries (steel, shipbuilding, coal), despite stimulus spending, are reliant on a pickup in global demand
• Fidelity: railways, materials and the property companies may benefit from stimulus efforts. Industry leaders may benefit from consolidation. The large scale railway expansion should also boost demand for steel and cement. Conversely financial services and energy companies place more challenges ahead
  
• Domestic retail sales continue to grow on the back of government subsidy programs and the wealth-effect of rising asset prices, however exports remain in contraction.
• Chinese oil demand returned to positive growth in April, and Chinese oil firms were able to use favorable credit conditions to purchase assets abroad when oil prices were depressed

p/s photos: Suzanne Sae

Hot Enough For You?!!

Readers of this blog will be aware that I have been saying the unbridled lending in China will need to find its way into assets, be it property of stocks. While I am concerned that this will end tearfully, I do think they will have a rambunctious party time before the sobering after effects. I only see things getting out of hand or collapsing sometime 2H 2010. Now we are seeing definite signs of this liquidity typhoon. Its rearing its ugly head viciously in HK's IPO markets.

That is one part of the equation, the other is the massive amount of liquidity resting by the sidelines for most of the past 12 months, and the equally massive stimulus programs, injections of liquidity and free printing press in the US and Europe ... all tipping their toes into the markets now. What we have been seeing are stock prices running ahead of fundamentals and recovery status.

Most analysts are trumpeting the same mantra: sell into strength, and being proven wrong royally (me included). Sometimes we can be wrong, but can we argue against momentum? We all have some sort of a "model" for valuing what is "fair price". So called experts (analysts, strategists, fund managers) have a more sophisticated model, in that we take into account in varying degrees ... interest rates, growth rates, bad debt levels, inventory levels, investment into R&D and purchasing, employment outlook, PE bands, breakeven levels for products, etc... many others have their own version, or heck, just when it feels right, its good enough.

The massive diversion of funds away from stocks into cash and T-bills 9 months ago has come back to haunt us in a different way. Just a sprinkling of monies back into funds (including international funds) will cause many fund managers to need to deploy into the markets. Especially if you are managing Asian based funds because the last thing you want is to try and time the market as you could MISS OUT.

Imagine if you were managing an Asian fund of just $150m as at April 2009, then suddenly over the last 4 weeks you see these feeder funds, these feeder channels plowing $50m of fresh funds into your fund each week. What are you to do? You have a strategy and market direction that thinks that stock prices may have run a bit ahead of fundamentals, but you now have an additional $200m added to your $150m, you run the risk of underperforming the Asian benchmark massively if you miss out - heads will roll and your company will suffer. If you put the $200m to work, and Asian markets correct a couple of months later - hey, you will still have a job, you are still marked to your Asian benchmarks. That's the craziness of being a fund manager.

Thats the same kind of craziness we are witnessing in this "hot money" flow. Can criticise them but don't stand in the way. In recent months, flows of hot money into China have accelerated. As a result, China's foreign reserves surged to a record high of $2.13trillion in June, even though it had only enjoyed a smallish second quarter trade surplus of $34.8 billion. Apart from hot money, massive lending by mainland banks is creating abundant liquidity, causing the Shanghai stock market to surge by 88.8per cent this year. In the first half of this year, mainland banks rushed to extend 7.37 trillion yuan in fresh loans. It sparked fears that fresh asset bubbles in China might be forming, as the money was diverted to stocks and property. To cope with such a surge of liquidity, Morgan Stanley said China may 'simply be allowing more hot money outflow indirectly into the Hong Kong stock market'.

Even Malaysia has benefited despite not being the center of the liquidity inflow. Just check out how the big indexed stocks have been performing over the last 3 weeks, and you have a very good idea that many international funds are parking in big index stocks so that they won't miss out: Tanjong, Commerz, Genting, Axiata, Sime Darby, AMMB, Parksons (even), B Toto, KLK, IOI etc.

In the unofficial market yesterday, the mainland cement maker surged 62.38 percent to HK$10.36 from an offer price of HK$6.38. Back to the HK's IPO: new Hong Kong listing BBMG Corp became this year's best performing player on the gray market as it soared more than 60 percent yesterday ahead of its stock exchange debut today. Based on its gray market price, BBMG was also the most profitable initial public offering stock as investors earned a paper gain of HK$1,990 per board lot of 500 shares.

Amber Energy, which saw a rise of 36 percent on the gray market, rose 63 percent on its debut early this month. BaWang International, which increased nearly 29 percent on the gray market, climbed 27 percent on its debut.

A total of more than 404,000 applications were filed by retail investors, worth HK$461 billion. BBMG's shares were oversubscribed 773.6 times. Investors who subscribed for 12 lots of BBMG shares are guaranteed one lot. The company reaped net proceeds of HK$5.575 billion from the global offering.

Meanwhile, mainland firm Sany Heavy Equipment plans to raise at least $200 million (HK$1.56 billion) in the Hong Kong listing market in the fourth quarter. For the mainland market, automaker Great Wall Motor is considering resurrecting plans for a domestic A-share IPO. China State Construction Engineering will list on the Shanghai bourse today after raising more than 50 billion yuan (HK$56.7 billion) as the world's largest IPO this year.

You know things are really getting hot when both Las Vegas Sands (Macau) and Wynn's (Macau) both are filing for IPOs in HK already. Iron is hot, iron is very hot... Las Vegas Sands Corp, controlled by billionaire Sheldon Adelson, plans to apply in Hong Kong for an initial public offering of shares in its Macau casinos in early August. The Las Vegas-based casino operator also seeks amendments to its bank borrowings in Macau, including covenant relief and permission to sell as much as $1.5 billion in new debt, said the person, declining to be identified as the plans aren’t public. Wynn Resorts has submitted an application to list its Macau unit on the Hong Kong stock exchange, hoping to raise between $500 million and $1 billion.

The following are some of the major companies planning initial public offerings
on the Hong Kong stock exchange:
China National Pharmaceutical Group (raising HK$1.3bn)
China Metallurgical Group (raising HK$1.3bn)
China Minsheng Bank (raising HK$2.93bn)
Agricultural Bank of China (raising HK$35 billion) in IPOs
split equally between Hong Kong and Shanghai.


        

p/s photos: Chrissie Chau

China's Lending Explosion

Is there anything wrong with China's lending spree. The central bank basically "advised" banks to ratchet up their lending, and the banks followed dutifully for the past couple of quarters with amazing results.

First of all, you cannot suddenly find so many attractive "borrowers" to lend aggressively to. Secondly, not many will say no when you offer to lend them money.

To be fair, this strategy pulled the domestic economy from falling further along with the ill effects of a global economy in crisis, but at what price. As I have mentioned before, this has to play itself out, and will not result in a sudden correction in property or stock prices in China. The liquidity rush will soon find its way into higher equity prices in China (hence bullish for the rest of the year for Chinese equity), and some may trickle back into Chinese property mart as well. Brace for high default rates when the music stops, probably after Chinese New Year in 2010.

China’s new lending more than doubled in June from a month earlier, increasing concerns bad loans and asset bubbles will emerge amid a credit boom.

New lending was 1.53 trillion yuan ($224 billion), the central bank said on its Web site today, bringing total lending this year to 7.4 trillion yuan. The calculation for new loans is preliminary, the central bank added.

The government is countering an export collapse by flooding the economy with money to fuel domestic demand. Rapid credit growth poses a risk to the nation’s lenders and a concentration of credit in some industries and businesses may damage the stability of the financial system, the banking regulator said yesterday.

Excess liquidity is fueling speculation and that means asset bubbles and wasteful investment. Already China recently failed to complete a $4.1bn auction of one-year government bonds, which suggested that investors are positioning for higher inflation caused by the credit surge.

Just something more to chew on, in 2005 Ernst & Young published a survey estimating that the bad loans in the Chinese banking system equaled close to $900 billion. Since then there has been enormous speculation in both the stock and real estate market. The average urban residential property prices fell by 15 to 30 per cent over the next two years from their levels at the end of 2008. Of course, by the end of 2008 they had already fallen from there 2007 highs. You cannot have real estate fall that much without having bad loans. Here is the juicy part, according to the prospectus for the Commercial Bank of China, it is illegal in China to foreclose on residential property.So what are bad loans? Bad loans = immediate write downs? No, they are then carried as what??? ... long term assets??? The reality is that no one knows exactly how bad the situation is in any bank. Information has value and is not disclosed unless required by law or for consideration. Since the banks in China are owned by the state, there is no legal requirement.


Something's gotta give ... but let's have a bull run first...

p/s photos: Elanne Kong Yuk Lam

China's Liquidity Traps & Benefits

China has been ramping up lending over the last 7 months. Yes, it was with good intentions. Yes, it was actual lending not just for show. Yes, banks in China were "asked" to do their bit to lend aggressively. While there is a lot of good to have money circulating around, it will also weigh down on those borrowing on the "unqualified" end of the spectrum, people who willing take on more debt than they should. Its a mini time bomb. No, it will not implode yet. What the figures below shows to me is that China's equity markets will have a major run up right through the end of 2009. When you pump in so much liquidity, there are very few places for it to surface. We may see a combustion effect only maybe in the second half of 2010.

China's credit card debt that was at least six months overdue rose 133.1 percent year on year in the first quarter to 4.97 billion yuan (727.67 million U.S. dollars), the People's Bank of China, or the central bank. Debt overdue by six months or more accounted for 3 percent of the total outstanding credit card debt at the end of March, or 0.6percentage point more than in the same period last year, the report said.

It warned of potential risks of the increasing overdue credit card debt as financial institutions expanded their credit card business. As of March 31, Chinese banks had issued more than 150 million credit cards, or 0.11 card per person, up 42.9 percent year on year. But Chinese consumers still have relatively few credit cards, compared with 4.39 per person in the United States and 0.95 in Brazil. Outstanding credit card loans rose 87.6 percent year-on-year to165.86 billion yuan at the end of March.

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New bank loans in China will exceed 1 trillion yuan (US$146 billion) and may top 1.2 trillion yuan this month as the regulator expressed its concern over irresponsible lending, according to a newspaper report.

This month's figure may be the third-highest this year after March's and January's, the China Securities Journal reported yesterday, citing people it didn't identify. That would also represent a sharp jump from May's 664.5 billion yuan.

The news, coming in the wake of the central bank's remark on Thursday that it will stick to an appropriately loose monetary policy to support economic growth, sent bank shares higher yesterday on expectations of better profit.

Shanghai Pudong Development Bank gained 3.79 percent to 22.98 yuan while the Industrial and Commercial Bank of China, the country's biggest lender, rose 2.02 percent to 5.55 yuan, easily outperforming the key Shanghai Composite Index.

Earlier this week, the China Banking Regulatory Commission demanded that lenders avoid a sudden jump in loans at the end of each month and each quarter, a move used by domestic banks to meet internal targets.

The regulator told lenders to ensure the money is channeled to the right sectors such as small businesses to help stimulate the economy, and to monitor capital flow into the stock and property markets.

This month's lending surge was mainly fueled by mortgage loans and funding of government projects, the Journal said.

The new bank loans in the first five months of the year have reached 5.84 trillion yuan, more than last year's total and exceeding the government's target of 5 trillion yuan for this year.


p/s photos: Zhou Weitong

Views On Chinese Equities

• Feb 24: After rising by 1/3 in early 2009, Shanghai Composite equities pared their gains to 20% as global and Chinese outlook worsened.
• Many of the new loans extended in December and January may have found their way into the equity market as investors seek better return on assets, this could imply that the lending surge is not being invested in sectors that will boost growth- and that stock market gains are vulnerable especially given that chinese equity returns have become more correlated with global trends
• Shenzhen equities rose 38% (Feb 16). The CSI fell 65% in 2008 as worsening global outlook, higher costs squeezing corporate profits, falling bank profits and government intervention are weighing on equities.
• Shanghai Composite Index, rose 9.3% in January, including three weekly gains before closing for the new year holiday. The Chinese equity market has rebounded since fiscal stimulus was announced in November 2008.
• Index may head towards the 200-day moving average at 2578 before a pullback. After the completion of a pullback, the index is expected to approach 2850 or 0.236x retracement level of the decline from the peak of 6429 (UOBKH)
• Citi: telecom and energy sectors may underperform, while highly geared companies, like financials, are likely to outperform Yet margin contraction, rising credit costs and decelerating fee income momentum will create downside risks for banks
Policy responses
• The government will ban cross-border fund flows, push publicly-traded companies to return more money to investors and toughen rules to punish insider trading
• China's cabinet approved a trial program for margin trading and short-selling even as other countries have imposed curbs on short selling. Shorting stocks could allow investors to hedge exposures but could be more destabilizing in the short-term
• China may allow investors to sell bonds that can be swapped for shares and may use brokerages as intermediaries to sell their shares rather than secondary market to ease pressure on share prices
• The Chinese equity market continues to be speculative because hedging tools are limited (deterring institutional investors) information on the companies is limited (Pettis) Level of government meddling in the market makes true transparency difficult (Hewitt) Many retail investors (who led the boom in 2007) have retreated to demand deposits
• Volume: Shares worth an average 118 billion yuan ($17 billion) changed hands every day on the Shanghai and Shenzhen stock exchanges early in 2008, 38% less than in 2007 (Bloomberg)
• Credit Suisse: the four most undervalued sectors are energy, materials, real estate. Consumer staples are relatively overbought
• Chinese equities may now be more susceptible to global outlook good or bad despite limited foreign investment in mainland equities. But it has also been driven by factors particular to China including previously high valuations, worries that anti-inflation measures would crimp growth
• Anderson: A-share capitalization now equals 40% of Chinese financial assets, a similar ratio to other markets
• In 2007. China's market capitalization $4.48 trillion or 140% of GDP. Average trading volume $26b. Chinese companies raised $62b in domestic market IPOs (WB) Shanghai index rose over 80% in 2007, smaller Shenzhen rose 120% in 2007 as limited investments, tax policies, RMB appreciation, negative deposit rates fueled share price boom

p/s photo: Natalie Tong Sze Wing