23 January 2019
Power generating firms may continue to benefit from industry reform. Photo: Xinhua
Power generating firms may continue to benefit from industry reform. Photo: Xinhua

How to identify Chinese stocks with strong potential

The mainland market is usually criticized as being policy driven.

Many investors are hesitant whether to jump onto the bandwagon given that the market has already gone up substantially.

In fact, a policy-driven market is not unique to China.

The Dow Jones Industrials index plunged to 41 in July 1932 from 381 points in September 1929.

Franklin Roosevelt unveiled his “New Deal” after becoming US president.

The US economy started to pick up after the massive stimulus package.

It’s the same with the quantitative easing program launched by the Federal Reserve in the United States in the wake of the 2008 financial crisis.

Chinese stocks have gone through years of a bear market and distressed valuations, as the market is skeptical about the country’s debt-driven economic growth model.

A large number of stocks have suffered valuation reratings month after month, and mainland banking stocks still have a price-earnings ratio of 7-8 times.

However, if the country’s new policies will lead to a more sustainable growth path, the market valuation is set to rebound.

The Hong Kong market still has a P/E of 11 times.

How should investors respond to that?

The key question is whether policies are able to address the real issues, as low-efficiency projects can only provide limited support for the broad economy.

And if the measures are clear and will last, company earnings will benefit from that.

Over the last two weeks, there has been a lot of news about Chinese power generating firms.

They are expected to obtain power distribution licenses as Beijing accelerates the reform of the power sector.

Also, the market is anticipating asset injection and consolidation of Hong Kong-listed units of mainland power groups.

It’s very difficult to speculate on market rumors, and the only way to benefit from a potential move is to hold the stock for the long term.

If the Chinese government is keen to tackle air pollution, it has to move in favor of power companies.

Meanwhile, nobody knows whether the Chinese central bank will cut the reserve requirement ratio for banks this weekend in light of potential deflation.

However, it’s quite possible that we will see several RRR reductions in the next year.

It remains unclear whether Shenzhen-Hong Kong Stock Connect will kick off before the third quarter.

But it’s certain there will be more measures to integrate the mainland and Hong Kong financial markets in the months ahead.

No matter whether A shares are included in the MSCI Emerging Markets Index or not, China is poised to account for a bigger weighting in the global economy, and global investors are set to recognize the significance of A shares.

Financial intermediary stocks are set to benefit from that trend.

These developments are set to last for years, and investors should wait for a good opportunity to accumulate relevant stocks and hold them for the long term.

This article appeared in the Hong Kong Economic Journal on June 10.

Translation by Julie Zhu

[Chinese version中文版]

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Columnist at the Hong Kong Economic Journal

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