Date
18 October 2017
Bank of America Merrill Lynch believes China's rapid expansion of debt will have a huge impact on the country's financial system. Photo: Bloomberg
Bank of America Merrill Lynch believes China's rapid expansion of debt will have a huge impact on the country's financial system. Photo: Bloomberg

BofA expects Shanghai stocks to fall 27% this year

Bank of America Merrill Lynch predicts 2016 will be a bad year for China’s stock markets, with the Shanghai Composite index expected to fall roughly 27 percent to about 2,600 points.

David Cui, head of China equity strategy, is worried over the rapid expansion of China’s debt.

“Historically, any country that grew debt this fast inevitably ran into financial-system problems, including currency devaluation, banking recap, and high inflation, and we do not expect China to be an exception,” Bloomberg quoted Cui as saying in a note.

“We believe that the government had maintained system stability over the past few years by allowing various implicit guarantees to get firmly entrenched, which has made the financial system fragile.”

The fragile equilibrium that has endured is a function of Chinese policymakers’ willingness to trade short-term gain for longer-term pain, he said.

Cui said the A-shares market is expensive. And if you strip out banks (for which the quality and sustainability of earnings may be in jeopardy in light of a deteriorating loan book), it only gets pricier, he warned.

It’s clear, however, that numerous countervailing forces could support the market and work against the strategist’s call for further declines.

These include liquidity provided by the People’s Bank of China through reverse-repurchase operations, larger owners being restricted from divesting holdings, direct purchases of equities by government funds, and a known distaste for allowing defaults.

However, Cui believes that a failure by the government to provide any of the major conditions investors are counting on to improve the market backdrop – namely, reaching the gross domestic product growth target, maintaining stability in the currency, a PBoC put in A shares, limited corporate defaults, and the evasion of a sizable real estate correction – would cause instability in the financial system.

“We believe that the most vulnerable is [the renminbi], followed by the A-share market, debt default and possibly housing price,” Cui wrote. “Any break of these ‘promises’ may be contagious.”

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FL/CG

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