Chinese Exuberance is Back

The Chinese stock market rally is back on. Last year’s sharp rise in Chinese stocks appears to be resuming after a flat 2015. The Shanghai Composite index jumped 1.6% yesterday to hit levels not seen since before the GFC.

This comes after a rally of more than 35% in Chinese stocks in just the last two months of 2014 — and 73% over the past year.

An interest rate cut in October by the People’s Bank of China — its first in two years —convinced investors the government would act to prop up the market. The Chinese rushed to open trading accounts, sold property to invest in the stock market, and took on margin loans to pump into the market.

The fact that China suffered the worst fall of all global stock markets from 2009 through 2014 seems to have been quickly forgotten. US markets recovered from their lows of 2009 and kept climbing. But the Chinese market couldn’t maintain a recovery and fell by more than 40% through to mid-2013.

As we know, the US government fuelled the American markets’ recovery with a series of bond purchases and interest rate cuts. The recovery was supported by cheap money. New record high levels were reached again and again, even though the economy remained weak with high unemployment and weak economic growth.

With that weak economy in mind, it’s understandable if you chose to sit in cash in recent years, avoiding the US market, and the Aussie market for that matter. But despite the government manipulation involved in the market’s rally, that decision would have seen you miss out on some great returns.

And now, it could be China’s turn.

There’s no doubt that China faces a host of issues. GDP growth has been falling since reaching almost 12% in 2010.

China is targeting economic growth of 7% this year, below the most recent rate of 7.3% in the fourth quarter. They’re trying to bring about a lower growth rate — a more manageable level that can be supported by a maturing consumer driven economy. Even so, it is struggling to meet its lower targets. And other issues such as rising debt levels, and the weakening property market are not helping.

But, as I explained last week, thanks to government assistance — or interference — bad economic news becomes good news for investors. In a promising sign for the stock market, the Chinese government says it will take whatever steps are necessary to overcome these issues.

Premier Li Keqiang reassured investors this week, telling reporters that the government is prepared to step in if needed to stop economic growth from falling to hard. Li said, ‘We still have a host of policy instruments at our disposal [and] are fully capable of forestalling systematic and regional financial risks.’

Of course, there’s the chance that the market has rallied too hard already. Annual returns of 72% simply aren’t sustainable. But while the market is back at five year highs, it remains a massive 42% below its 2007 peak. The US market surpassed its 2007 peak two years ago.

Yet the Chinese market may well have further to run thanks to the government being more than willing to step in as needed to support the economy, and stock market.

As mentioned, the government cut borrowing rates last year and they are now cutting red tape, making it easier for start up businesses to get funding. And in addition to steps like these that support economic growth, the government last year opened up China’s stock market to foreign investors.

But these measures are seen by many to not go far enough. In 2013 the government pledged to make significant economic reforms. A big one being reducing the power of state owned enterprises.

While Premier Li was adamant this week that the government could overcome China’s economic issues, he made no mention of challenging state owned enterprises or the dominance of the country’s major banks.

Yet so far it seems to be enough to support the stock market.

If you’re tempted to invest into this trend, the easiest way for Australians to access the Chinese market is with an ASX-listed, China-focussed ETF. The iShares China Large Cap ETF [ASX:IZZ] tracks the performance of 50 large-cap Chinese companies trading on the Hong Kong exchange. Over the past year, the ETF is up 50%. While there’s no ETF tracking the Shanghai market, the NYSE has some available for those of you with an international trading account.

I have recommended a number of stocks in the Australian Investors Club that are leveraged to China’s urbanising population. All of them are up since my recommendation. If you want to know more, here’s a good place to start.

And if you want the inside scoop on what’s happening in China, I suggest you check out Ken Wangdong’s New Frontier Investorfor direct investment opportunities in Chinese companies on the Hong Kong exchange.

Meagan Evans,
Investment Analyst, Australian Investors Club

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Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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