Is the Worst Over for China Stocks?
Feeling Bullish on the China Economy?
Are China plays out of the woods?
With all due respect to Dr. Doom and his many pessimistic followers, we bulls in the China shop have received some fresh support. “The market has reached its bottom this year and is poised for a rebound,” Xu Lirong of Franklin Templeton in Shanghai told Bloomberg News, defying all of the skeptics.
About: Dr. Doom, Marc Faber, Xu Lirong of Franklin Templeton, Shanghai Composite Index, Shanghai Index, Chinese stock, China A Shares, China ADR Index, Chinese export market
The Shanghai Composite Index hit a low for 2010 on Tuesday, giving the doubters new reason to dismiss Chinese stocks. As we have discussed before, China’s A shares are suffering from a serious case of nerves about the prospect of economic tightening from Beijing.
In fact, Beijing has already raised bank reserve ratios several times this year, introduced a host of measures to dampen property speculation and instructed banks to reduce the flow of loans without shutting off the spigot completely.
But news that China’s property prices rose by a record 12.8 percent year-over-year in April sparked new investor fears on the mainland. An uptick in inflation to 2.8 percent from the previous month’s 2.4% also sparked worries that a long-awaited interest rate rise was inevitable.
Here’s the key point. A Chinese interest rate rise is inevitable. So is another increase in the bank reserve ratio. Everyone in the investment community expects further tightening in bank lending and mortgage rules to squeeze the air out of the property bubble. And when ‘everyone’ expects an economic event, it is almost certainly priced into the market.
Very few news reports and even fewer readers make the essential distinction between the Shanghai Composite Index and the China ADR Index. They behave very differently. The Shanghai Index reflects the highly volatile fears and expectations of mainland China investors. It is sometimes seriously overvalued and sometimes undervalued as fears increase. The China ADR Index is far less volatile because, unlike China, trends are driven largely by professional investors who are focused on more realistically on valuation.
Courtesy Google Finance
The Shanghai Composite Index (in blue) sometimes follows and sometimes leads the ADR index and it is always more volatile. As you can see in this one-year chart, fear is at a peak in Shanghai, even though ADRs (in red) are rebounding.
This is a visual demonstration that fear is priced into the Shanghai market.
It is also worth noting that April real estate price increases seem exceptionally high because they stand in comparison to a low base during the slump of in 2009. Authorities say they expect a time lag for tightening real estate policies to take effect because of continuing high demand.
The real economy is also sending more signals of a rebound with China’s exports increasing at a faster-than-estimated 30.5 percent in April. The European bailout has also eased fears that a key Chinese export market, Europe, would face another economic crisis.
As we can see, the ADR market is getting over its latest bout of nerves. Shanghai fell much further, much faster. Now it seems due for a strong recovery, as maximum fear is priced in, and economic reality returns to dominance.
