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China equities euphoria: is the rally sustainable?

China equities euphoria: is the rally sustainable?

In recent days, Chinese equities have sprinted to record highs.

Hong Kong stocks ended last week at a seven-year high, posting their biggest weekly gain in more than three years. In the mainland too, the Shanghai Composite Index closed above the 4,000 level for the first time since 2008.

That's not all: for the first time, Chinese investors used the entire daily quota of 105 million yuan ($1.7 billion) under the Shanghai Hong Kong Stock Connect, lifting turnover under the stock link scheme to a record high.

Part of the exuberance is driven by expectations of more monetary easing in China, while some of it is also attributable to an easing of rules allowing mainland mutual funds to invest in HK shares through the HK-Shanghai Connect without a licence.

Citywire Asia canvassed the views of top market experts to find out whether they believe the rally is sustainable.

William Fong, Barings AM

Barings AM Manager of Baring China Select Fund

The market rally was mainly bolstered by a stronger interest in the Hong Kong stock market by mainland investors, who also started investing via the Shanghai-Hong Kong Stock Connect Scheme.

While we believe the short term volatility of Hong Kong market could increase, we believe there is further room for the market to go up.

Valuation of Hong Kong market remains attractive versus other regions, even after the strong rally since April. It is anticipated that the Shenzhen-Hong Kong Stock Connect, which will be ready by the end of this year, will further facilitate liquidity to the market.

We expect China will continue to face some downward pressure in terms of growth. However, the government is determined to support the growth and more importantly, a more sustainable long term growth through structural reform.

To a certain extent, this is a driver for the re-rating in the Hong Kong market. We also believe the previous rounds of monetary easing and infrastructure spending should moderate the slow down in the second half of 2015.

Sherwood Zhang, Matthews Asia

Co-manager of the China Dividend Strategy

We believe that the A-share market growth is sustainable over the long term.

The background on the market’s recent rally is that China’s economy is slowing down and it faces some disinflationary pressure, which is why the central bank is implementing looser monetary policy by cutting both interest and the required reserve rates.

This incremental liquidity is driving down the risk free rate in China - one of the key drivers of the re-rating of China A shares from their low levels last year.

The other factor is that there is a growing expectation that China A shares could be included into the MSCI World Index which is encouraging further domestic investments.

In term of the sustainability of the growth, I think we are probably in a long-term virtuous circle largely due to sentiment change. However, it could be due for a short-term correction, as the valuations of some small-cap companies are just too high.

The most recent rally in H shares follows the approval from the Chinese securities regulator for domestic mutual funds to invest directly into the Hong Kong market through the Shanghai-Hong Kong Stock Connect program.

It is likely that since then, Hong Kong domiciled investors have been increasing their positions ahead of any major move from the mainland’s mutual funds.  

Kai Kong Chay, Manulife AM

Managing director and senior portfolio manager for Greater China equities

We remain positive on the A-shares market for 2015.

The Chinese government continues to strike a balance between pursuing economic reform to lay a foundation for stable long-term growth and implementing economic stimulus to maintain robust growth and job creation.

We expect monetary policy easing to continue to be a strong economic growth driver. The current equity market offers attractive valuations.  

The Shanghai-Hong Kong Stock Connect scheme and the upcoming Shenzhen-Hong Kong Stock Connect scheme will continue to open China’s capital account and ultimately open up to a potentially large source of investor demand for A-shares.

Other factors supporting the A-shares includes the possible inclusion in MSCI indices, deflationary pressure, low oil prices and continued integration of China’s economy with the wider region.

Aidan Yao, AXA IM

Senior emerging Asia economist

The strong rally in the Chinese equity markets since the second half of last year was driven by a combination of policy easing expectations, optimism about structural reforms, and a structural shift of household portfolio from real-estate and bank deposits to equities.

This has led to a marked divergence of performance between the equity markets and the economy, as investors look beyond the near-term headwinds and focus on the long-run prospects of the economy and corporate earnings.

Given that most of these structural positives will remain in place, we think there are still upsides for A shares over the medium term.

In the near-term though, the markets do look a little frothy at current levels, given the pace and scale of the run-up. In comparison, we think H shares trading in Hong Kong look more attractive from a valuation perspective.

The recent strong rally in the HSI, underscored by record inflows, suggests investors are starting to take advantage of the cheaper valuation.

Ken Wong, Eastspring Investments

Asia equity client portfolio manager

The recent rally has been driven by large demand by mainland Chinese investors.

With the relaxation of a QDII license needed for the mainland Chinese fund houses to buy Hong Kong listed shares, that has created a lot of positive sentiment and momentum for the offshore Chinese markets.

As a result we have also seen a large pick up in trading activities for the southbound Shanghai Hong Kong Stock Connect Program over the past few days which has further fuelled the rally in offshore Chinese equity markets.

Of course this type of rally where stocks go up by double digit percentage gains daily is not sustainable.

But with that said, MSCI China is still trading at low valuations and remains relatively cheaper than the Chinese A-share market so a continued rally / outperformance against the Chinese A-share market is possible.

Nicholas Chui, Aberdeen Asset Management

Assistant IM on China/HK equities

In short, the recent rally is a speculative activity. Investors have latched on to the “bad is good” idea, that is, a poorly performing economy would compel further stimulus from the central government. Since we’ve yet to see concrete signs of a pick-up in the Chinese economy, more easing measures cannot be ruled out. In the short term, share prices could conceivably be driven higher, especially given that benchmark-driven fund managers are also likely to be forced into chasing the rally.

Whether the rally is sustainable over a longer period is difficult to predict because the market run-up betrays an obvious disconnect to the sluggish corporate and economic conditions. This is particularly true for certain A-share names that have been trading consistently at excessive valuations.

In such an environment, we’re cautious and will continue to focus on buying good-quality companies at reasonable valuations. While some of our holdings have benefited from the market run-up, we will take profit as valuations turn frothy.

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