18 August 2019
China's stock market rally has been fueled by government policy hopes rather than corporate earnings. Photo: CNSA
China's stock market rally has been fueled by government policy hopes rather than corporate earnings. Photo: CNSA

What to buy in a bull market

The recent rally in Chinese stocks was driven by government policy-related speculation, rather than company earnings. 

Zhou Xiaochuan, the central bank governor, said on the sidelines of the parliament session last month that capital flows into the stock market can be taken as a vote of confidence in the economy.

Meanwhile, in an article published on Monday this week, the Communist Party mouthpiece People’s Daily urged investors to capture the bull market in A-shares.

The comments make it clear that Chinese authorities are sending a message of support for the equity market.

Meanwhile, lower interest rates — which stemmed partly from reduced demand for funds as Beijing abandoned its long-term obsession with economic growth targets — also helped buoy equity prices and shore up market confidence.

In fact, it’s not unusual to see divergence between equity market and economic growth. Warren Buffet once noted that the gross national product in the US soared 373 percent between 1964 and 1981, while the nation’s main stock market index barely moved during the period.

The stock market is of course influenced by the economy, but interest rates are the larger and more substantial guiding force. The US Federal funds rate jumped to 13.65 percent in 1981 from 4.2 percent in 1964, but then fell back to 5 percent in 1998.

Now, keeping such interest rate factor in mind, where should investors should place their money in China? Should they continue to chase the booming A-shares or look at other options?

Giving a serious thought, H-shares traded in Hong Kong may represent a better bet.

The underlying force behind the China market rally is that Beijing will stimulate the economy by encouraging equity financing. However, mainland companies have to go through lengthy approval processes for capital-raising at home, which will prompt them to look at the Hong Kong market.

This could energize H-shares and reduce the valuation gap with their mainland peers.

China’s massive 1.4 trillion yuan mutual funds have been given the green light to access H-shares without QDII quota, according to a recent announcement from the China Securities Regulatory Commission. That’s the reason why H-shares shot up on Monday.

South-bound trading has a quota of only 250 billion yuan. What the authorities are trying to do is to attract retail players and fund managers after channeling some money into the Hong Kong market.

The funds will subsequently lure more investors amid a steadily rising market. 

Equity financing seems to be the only option as debt-financing can’t last forever. However, someone has to pay the price for the local government debts and bad loans lent to mainland companies.

Therefore, this round of market rally is set to be short-lived like in 2009. The party may wind up when a number of listed companies raise funds as we’ve seen in late 2010.

The best-performing stocks recently are those that lagged behind for quite some time and were driven merely by market rumors.

For those who are optimistic about the market outlook, they should consider placing bets on mainland insurance and Hong Kong brokerage plays.

This article appeared in the Hong Kong Economic Journal on April 1.

Translation by Julie Zhu

[Chinese version 中文版]

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Columnist at the Hong Kong Economic Journal

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