25 October 2016
Retail investors account for 80 percent of the A-share market turnover, and Beijing is worried any deep market correction could trigger a disaster. Photo: Reuters
Retail investors account for 80 percent of the A-share market turnover, and Beijing is worried any deep market correction could trigger a disaster. Photo: Reuters

Why Chinese stocks are more attractive than US counterparts

Mainland regulators, along with state-run media, have spared no effort to reduce the volatility of A shares as retail investors account for 80 percent of the market turnover.

Today’s young investors are very aggressive with very limited experience in a bull market. Beijing is worried that any deep market correction could trigger a disaster.

A healthy bull market benefits everyone. It would buy time for state-owned enterprises to deepen reform and consolidation. The longer the bull market lasts, the more capital will be drawn into the market. It would also encourage state-owned and private companies to seek public listing, issue shares and bonds to raise funds and reduce their operating costs.

The growth enterprise board will encourage more start-ups and entrepreneurs; wealth creation and incremental domestic demand along with the bull market will be very significant.

The Chinese government has to tread very carefully and avert any crazy bull market which could lead to serious economic and social issues.

The velocity of mainland mutual funds has reached 500 percent, compared with below 100 percent for accredited mainland funds in Hong Kong. The turnover ratio of mainland retail investors is even higher. That’s why trading and turnover of A shares are far exceeding those in Hong Kong, thus justifying the price premium on the mainland market.

The mainland market is running, while the Hong Kong market is jogging. Investors have to learn to adjust their pace in the Hong Kong market.

China’s financial system will become more mature on the back of a massive domestic market. It will become an attractive capital-raising venue for foreign and domestic companies, and lure funds from various sources.

The price-earnings ratio of the domestic growth enterprise board stays at around 90 times, compared with 54 times for Nasdaq’s biotech index.

The valuation gap has attracted some outstanding professionals to come back to China and develop high-tech and pharmaceutical companies. The country has already formed three versions of the Silicon Valley in Shenzhen, Hangzhou and Beijing’s Zhongguancun Science and Technology Park.

Apart from government support, talent, money and market are also key elements. These start-ups could seek listing in the A-share markets. If these talent pools of doctors as well as healthcare and biotech professionals continue to come to China, the impact on the United States could be great.

The US market has posted a rally for six straight years, and investors have opted for US bonds due to the strong greenback. Germany’s two-year and five-year bonds are offering negative yields, while the 10-year bonds only offer a 0.1 percent yield. By contrast, the 10-year US and Japan bonds still offer 1.9 percent and 0.3 percent respectively. That’s why US bonds remain so attractive despite the high price.

The Chinese market remains attractive in terms of valuation. The CSI 300 P/E stands at 13, compared with the average level of 16.4. The MSCI China P/E averages 12.7, the price-to-book ratio is only 1.4 compared with the average level of 2.

Mark Mobius of Franklin Templeton has also changed his tune, telling investors to sell US stocks and buy Chinese shares.

He warned, however, that the A-share market could see a 20 percent correction. But that seems unlikely unless the China’s economic growth slows sharply and inflation shoots up.

It’s another story if Beijing feels the market rallied too fast and rolls out some cooling measures.

The market correction is likely to be capped within 10 to 15 percent, with the Shanghai Composite Index probably dropping to 4,000 points.

However, market correction is still out of sight, considering the central government’s recent remarks.

This article appeared in the Hong Kong Economic Journal on April 23.

Translation by Julie Zhu

[Chinese version中文版] 

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Founder and Managing Director of Pegasus Fund Managers Ltd.

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