A bear market is often defined as a 20% fall in stock prices within a year. The Shanghai Composite Index (SCI) achieved this in about a month and a half in 2007 as it slid from its mid-October peak of 6,092.06 points to 4,941.78 near the end of December. But this was a mere blip compared to the bull run that preceded it, the SCI gaining 124% between January and October.
By all accounts, the correction was partly government-induced. An embargo on new mutual funds put the brakes on institutional money, while a clampdown on bank lending helped curb free-spending retail players. But investors know such restrictions don’t last forever and so remain positive about 2008.
“The policy makers don’t want to see the stock market tumble; they just want investors to realize that the bubble can burst,” said Alex Guo, an analyst at Everbright Securities in Shanghai. “Most institutional investors are optimistic about 2008 and believe the index will surpass 6,000 points and may even reach 8,000.”
But the journey is unlikely to be a smooth one. Lan Xue, head of China research at Citi, warns that inflationary pressures and Beijing’s desire to rein in growth could take some of the momentum out of the A-share market and mainland-related stocks listed in Hong Kong.
Her top picks of H-shares and the red chips – Hong Kong-listed Chinese companies incorporated in the mainland and overseas respectively – are focused on the consumer sector. The likes of dairy firm Mengniu and department store operators InTime and Golden Eagle are expected to be buoyed by rising household spending. Telecom and infrastructure players are also tipped to do well.
The stars of 2007 – banking, insurance, commodity and property stocks – are deemed to have outperformed and could see their progress restricted by the tightening credit environment.
Meanwhile, Xue believes the impact of funds flowing into Hong Kong through the Qualified Domestic Institutional Investor (QDII) scheme has been overstated. The money will still come – JPMorgan says Hong Kong will get a third of the US$90 billion in QDII funds that will leave China by the end of 2008 – but the effects may be muted.
“The Hong Kong market went up 20% in three months largely due to QDII, but the scheme is about allowing Chinese investors to diversify their holdings, not boost the Hong Kong market,” Xue said.
Market watchers also have reservations about the H-share “through-train” scheme, which allows mainland residents to invest directly in Hong Kong stocks. It was announced with much fanfare by the State Administration of Foreign Exchange only to then be shelved amid rumors that the major financial regulators weren’t properly consulted.
Fraser Howie, co-author of Privatizing China, notes that the through-train framework doesn’t tally with the way in which Beijing normally operates.
“Beijing is reasonably happy with things provided it can control them. You can control institutions investing under QDII but when it is retail investors there are ways of getting around the controls.”
As capital flows out of the mainland, Hong Kong-listed Chinese companies are set to continue moving back in by selling shares on mainland bourses. This is in keeping with Beijing’s policy of increasing the supply of good quality stocks.
Listing candidates include H-shares such as China Coal, Zijin Mining and Great Wall Auto as well as red chips like China Mobile. However, some technical hurdles still have to be cleared if the red chips are to return.
“They are effectively Hong Kong companies and are not subject to Chinese laws, which means there may be some regulations they can’t comply with,” said Richard Sun, a partner with PricewaterhouseCoopers’s capital market services group in Hong Kong. “But these companies have business in the mainland and they want to raise renminbi funds.”
As of mid-December, US$91.3 billion had been raised from 213 offerings on mainland bourses since the beginning of 2007. Thomson Financial was expecting a further 14 deals to push the full-year total to a world-leading US$99.1 billion. Sun believes this mainland momentum will continue into 2008 while Hong Kong serves a growing number of private sector firms, particularly real estate and consumer-focused players.
A major breakthrough for the A-share market could come with the introduction of stock index futures, which are tipped for launch in early 2008 after more than two years of discussion. The products are intended to allow investors to hedge their risk, and strict controls will be placed on price movements so the market doesn’t become too volatile.
Howie, though, is not convinced, citing Beijing’s much-talk-little-action approach to futures as an example of “how development is really weak in China.”
He has less faith in the market than most, arguing that strong liquidity pushing up prices that are already overinflated (the mainland’s average price-to-equity ratio is 50 compared to 18 in Hong Kong) can only result in one thing.
“Something will happen and people will realize the market is unsustainable,” he said. “The party can’t go on forever.”