Winds of change?

At time of writing, the motley collection of social delinquents behind the Red Dragon Fund were all worrying about Typhoon Wipha.

With potentially the most destructive storm in a decade bearing down upon Shanghai, it was time to think about the important things in life. Should we bring a spare pair of shoes to the office tomorrow? Should we bother turning up to the office at all? And finally, will the waves be felt by the Shanghai stock market?

The market was the last of our concerns because, to all intents and purposes, it has been in the thrall of a typhoon for the best part of a year now.

The Shanghai Composite Index (SCI) has risen about 90% so far this year and is now above 5,400 points. In August alone, it ended 15 sessions at new highs.

Sure, the news that China’s inflation rate hit an 11-year high in August rattled the market – it closed down 4.51% on September 11 – but it rallied and the interest rate hike announced a few days later left barely a blemish on its scorecard.

So a pesky meteorological phenomenon? It may have ruined a few traders’ lunches but they were probably back in their stride come the following teatime.

Costly caution

In these heady times, the Red Dragon Fund’s aversion to risk has cost it somewhat. Harbin Harbin Pharmaceutical 600362 was sold for a small profit, Shanghai Jinqiao 600639 – which has underperformed the real estate sector – was jettisoned at a small loss.

But there is still a 40% floating profit on Shanghai Petrochemical 600688 and Jiangxi Ganyue Expressway 600269 has been brought into the portfolio. With its low price-to-earnings ratio and fast-growing business, Ganyue should prove to be a strong long-term bet.

Making corrections

Looking forward, the signs point to a medium-term correction in the A-share market as the relationship between share supply and demand reverses.

This is not just about the “through train” scheme that allows individual mainland investors to buy Hong Kong stocks. If and when it is approved, funds will certainly flow to Hong Kong – not least because shares listed in both Hong Kong and Shanghai are trading at a relative discount down south.

But the other reasons for a possible correction are more compelling.

First of all, H-shares continue to debut in the A-share market. China Construction Bank and China Shenhua Energy are among the next to list and both are expected surpass the current record of US$5.9 billion raised by Industrial and Commercial Bank of China a year ago. The more money locked up in subscriptions, the less the overall liquidity.

Secondly, the non-tradable to tradable stock transfer program is reaching a climax: Only 2.2 billion such shares were due on sale in September but this will rise to over 11.3 billion in October. This means another US$30-40 billion will be drawn from the market.

 Last but not the least, there is the macroeconomic situation. The most recent interest rate hike may have failed to stall the stock market but this doesn’t mean that other hikes will not. And economists say there will be one or two more of them before the year is out.

With growth in A-share supply pulling investors in one direction and macro tightening measures pulling them in the other, ready cash is going to become thinner on the ground.