When a market goes up quickly, a similarly rapid fall is all but guaranteed. China is no exception. As of mid-July, the Shanghai Composite Index (SCI) lost about half its value since reaching a record high of over 6,000 points in October. At one point in June, the index fell 10 consecutive days to close at around 2,800 points, recording the biggest drop in a year – 7.7% – along the way.
In these difficult times, the question on investors’ minds is: What will the government do about it? The perception here, rightly or wrongly, is that the market moves according to the state’s mandate.
“I don’t have confidence in the market because even the government itself doesn’t have confidence in it,” said Li Ji, a 28-year-old employee at a local media company. “Technically speaking, the market features very good investment value. But it continues to drop.”
Although most market watchers, Chinese and foreign, advocate allowing the capital markets to find their own equilibrium, Beijing still seems keen to intervene. A Shanghai-based source with ties to the securities regulator said that new measures intended to revive the market were on the way, although there is no timetable for their implementation. “The biggest concern is whether conducting any innovation will further spook sentiment,” the source said.
Ironically, government influence is in part responsible for the SCI’s underperformance in recent months. Interest rate hikes and bank lending restrictions have been the hallmarks of recent macroeconomic policy, and investors are living in fear of further credit tightening.
Erosion of confidence
The climate of uncertainty has affected corporate earnings outlooks. Facing higher costs – from rising labor expenses to increasing fuel and raw material prices – it is uncertain whether companies can maintain their impressive financial performances of recent times.
The fuel and electricity price situation, specifically Beijing’s policy of controlling the prices of retail fuel products in order to keep them affordable, has made life particularly difficult for the energy sector. Power producers like Huaneng and state-run oil firms such as PetroChina are also SCI heavyweights – when they fare poorly so does the index.
“Listed companies’ earnings are heavily weighted toward refiners and [independent power producers], and thus a lift in price caps would boost the broad earnings outlook,” Jing Ulrich, JPMorgan’s chairman of China equities, wrote in a recent note to clients.
On a general level, one measure rumored to be under consideration is an alteration in the stamp duty paid on all stock market transactions. The duty was raised in May 2007 to rein in the market and then cut last April as the SCI floundered. The current proposal involves making it a one-way tax, meaning it is paid only when a security is sold.
The government could also pull the levers of share supply and demand. Approvals of new domestic mutual funds have restarted and the Qualified Foreign Institutional Investor quota has been increased from US$10 billion to US$30 billion. With more money chasing equities, it is hoped that prices will rise across the board.
On the supply side, the regulator is already slowing down the number of new offerings and imposing new rules on non-tradable shares.
It has also been suggested that the government calm market jitters by delaying new products like stock index futures. Although beneficial in the long term, investors have in the past linked such innovations to possible speculation. This, in turn, triggers sell-offs.
Despite the bearish sentiment surrounding the markets, investors who are willing to put their money in Chinese equities for the long term could be rewarded with a buying opportunity. According to Capital Economics, average price-to-earnings (PE) ratios of stocks on mainland exchanges are now in line with global averages. The PE ratio for the SCI is down from 50 at the end of last year to just over 20 in June. This figure is similar to the S&P 500’s ratio, and slightly higher than the India Sensex number.
Sectors to watch
The sectors that are likely to provide the best returns over the long term are agriculture and consumer goods and services, said Chew Boon Leong at independent equity research firm Riedel Research. He reasons that tighter monetary policy from the government is unlikely to affect small-ticket consumer items, like cosmetics or sporting goods, while rising affluence will translate to more spending.
Ding Jun, a fund manager at Fortis Haitong Investment Management, expects some manufacturing enterprises to experience a price correction due to poor interim reports, but he remains bullish about the financial sector. “The overall economic condition is not as pessimistic as previously estimated and a majority of stocks have returned to reasonable valuations,” Ding said. “But it doesn’t necessarily mean the market has already reached its bottom.”
From the government’s point of view, it is more a case of how low it thinks it can let the index fall. Although the stock market is still quite small relative to the size of the economy as a whole, there are social issues to consider. Many retail investors bought in at a high level and don’t have the means to bear further losses.
Zheng Tianhui, a 26-year-old office worker at a multinational company in Shanghai, has already postponed renovations to her apartment due to a lack of money.
“I will pull out if the index goes up by more than a quarter even if I still book a loss for the investment,” she said. “I don’t want to sell now because the loss will be too big for me to afford.”