A shares headed south after ending a four-day rally, and the latest consumer price index figure has sparked market concern about deflationary pressure.
China will go through a painful period of economic restructuring, which will make the mainland stock market and economy more unpredictable.
The CPI rose 1.3 percent in October from a year earlier, less than the 1.6 percent in September.
Also, the producer price index dropped 5.9 percent last month, extending its decline for the 44th straight month.
The central government has to expand its monetary easing given the mounting deflationary risk and falling exports.
The Chinese central bank is trying to stabilize economic growth without inflating debt aggressively.
It has imposed rate cuts six times over the past year.
Decreasing prices, heavy debt and stubbornly high interest rates will exert pressure on the balance sheets of firms, which will harm their ability to pay off debt and their demand for investments, a report from UBS said.
As a result, the asset quality of Chinese banks could deteriorate.
Beijing has to step up its efforts in economic restructuring and further relax monetary policy.
Meanwhile, CICC said in a report that the market is less visible in 2016, and investors should watch closely on three main issues. How falling risk-free interest rate affects valuation? How lower interest rate impact corporates financial status? The potential impact of large-scale merger&acquisition on company earnings?
The Chinese investment bank noted that the market has less visibility next year, given weak growth momentum in China’s economy and lackluster external demand.
The property market may weaken next year, while the authorities will maintain loose liquidity within expectations.
The bank estimated growth in China’s gross domestic product at 6.8 percent in 2016, and A-share earnings to rise modestly by 4 percent, while non-financials may post a rise of 9.8 percent.
Meanwhile, the risk-free rate, risk premiums and market valuations are three main factors that will affect A shares next year.
Over the last two years, A shares have posted a sharp expansion in valuation due to the falling risk-free rate.
However, risk premiums might increase if economic growth continues to decline, which might spark fears about credit risk and financial system instability.
Lower interest rates would help save financing expenses as well as stimulate demand.
Domestic non-financial listed companies report that financial costs account for 1.5 percent of their revenue, and interest rate expense represents 2.2 percent.
Every rate cut of 0.25 percentage point would lower interest rate expense by 5.6 percent.
In recent years, the earnings growth of many non-financial companies stemmed from external growth through mergers and acquisitions.
The contribution from organic growth continues to slide and has even dragged down overall profit growth in some old-economy sectors.
In small-cap and startup firms, organic growth continues to generate profit, while external expansion contributed up to 70 percent of their earnings growth.
CICC has not arrived at any conclusion on the outlook for A shares.
However, China’s top leaders have repeatedly mentioned the stock market recently, and they hope the stock market will help create wealth and boost consumption.
So, the outlook for A shares remains positive.
By contrast, non-US markets might face sell-offs in the short term.
Emerging markets, in particular, have already posted abnormal slides.
This article appeared in the Hong Kong Economic Journal on Nov. 11.
Translation by Julie Zhu
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