China’s stock markets have come down between 12% (Hang Seng Index) and 25% (Shanghai SE A Share Index,
Shenzhen SE B Share Index) from their recent highs
The mainland CSI 300 Index has fallen 15%* over the last two weeks. Even so, this simply takes markets back to their April levels, leaving large year-to-date gains.
- The Chinese authorities have reacted in a number of ways. The People’s Bank of China (PBoC) has reduced its reserve requirement ratio (RRR) on a targeted basis and has cut both policy deposit rates and policy lending rates by 25bps – cuts to both rates and the RRR together are rare and were unexpected. The loan-to-deposit cap of 75% has been removed. In addition, the PBoC has restarted its 7-day reverse repo operation, with a net liquidity injection accompanied by a cut in the rate, and has extended its medium-term lending facility (MLF) in terms of both size and available terms.
- There has been speculation that stamp duty could be stopped and that the number of initial public offerings (IPOs) could be reduced – even to zero – in order not to draw out more liquidity of the market.
- Chinese domestic stock markets have shown little correlation with global capital markets. They seem to be driven by short-term oriented retail investors that are trading on margin and are heavily influenced by expectations over policies.
- Strategically, China remains one of our favorite emerging-market plays. We reduced exposure to the market earlier this year but think that this correction may provide new entry points. We prefer bonds over equities and within equities largecap, high-quality stocks.
Chinese economy to pick up in the second half of 2015, capital markets should benefit from further liberalization
We stick to our 2015 gross-domestic-product (GDP) growth forecast of 6.8% and believe that economic momentum will pick up in the second half of 2015. The real estate market is showing signs of improvement in prime cities and the various stimulus programs should start to kick in. Wealth effects from equity ownership are not that important in China with real estate having around four times the weight in personal wealth. Nonetheless, Beijing is keen to have a well-functioning equity market, in order to facilitate IPOs and non-debt financing of enterprises. We therefore see the recent measures not as a knee-jerk reaction, but as more (and predictable) steps in Beijing’s quest to liberalize markets. But the government is also keen not to further inflate the equity market, hence its steps in both January and May to curb margin trading. We believe domestic markets are primarily driven by policy action (or expectations of it), not valuation. Looking to the long term, we think that foreigners still under-own Chinese stocks and this, together with market liberalization, provides upside potential. But we still prefer Hang Seng (i.e. Hong Kong-listed) to local exchanges.
We prefer Chinese bonds over equities; wait for new entry points into equities
- Equities: Equities will remain driven by policy changes (or expectations of it), retail investors and momentum – not valuation. This means that the market should remain volatile in the short term. We prefer high quality large-cap stocks. Should markets fall further, it is likely that the stocks that will have climbed the most will be most vulnerable to reversing their gains. Sectors therefore at risk include internet, retail/consumer brands and entertainment. Small cap stocks also appear vulnerable. However, over the longer term, we remain constructive on Chinese equities.
- Fixed Income: We expect further rate cuts. Local-rates still appeal. Chinese corporates have been affected by the economic slowdown, and we remain neutral here, but still see some opportunities in credit, notably hard currency bonds of asset managers, financials and selective property companies.
- Currencies: EM currencies may prove volatile in coming months, but the renminbi (RMB) is likely to prove relatively stable, thanks to its quasi-peg to the U.S. dollar. This peg means that it has remained quite stable to the U.S. dollar over the past year, but the Chinese authorities show no signs of wanting to engage in competitive devaluations of the RMB.
Deutsche Asset & Wealth Management