China – Oops! Minus 20% – time to get nervous ? Not yet

To be honest, the China piece required the deepest thinking, so you get some extra. When a stock market drops 20% within 2½ weeks, and furthermore in an economy that lives on a public boost and excess liquidity the thinking needs to be accurate. The drop was over a period long enough to be traded, and not just a couple of days with panic. This makes the set-back more remarkable.

The boost and the bubble

The equity market got a boost from the very famous anti recession package. It’s ok that this supported the stock market, but the bubble like rise since March is caused by the sharp lending increase from all banks to the corporate and private sector. I have earlier mentioned that 20% of the lending went into the stock market on the mainland and in Hong Kong.

It is now widespread knowledge and seen as a fact, also understood by China’s State Council. There have been official comments indicating that this will have an end and all banks have suddenly announced a pull back in lending for the rest of this year. No surprise that the market gets more nervous when this cash generator disappears.

Fundamentally it just means less inflow of risk capital in the second half of this year. What we all are watching is if the speculative capital from the spring will move out of the market again. There are no signs yet, but it makes the moves more choppy.

Commercial properties will get a boost

Since end of last year bankruptcies among Chinese real estate developers have been expected. Most have actually survived after they sold out at fire sale prices. After a panic sale or forced sale markets normally sees the lows as a bottom and is ready to buy at higher levels. In addition the general rebound in China naturally also comforts the commercial property market.

There are clear signs of higher risk appetite towards commercial real estate in Hong Kong and China mainland.

On 29^th July Hong Kong Stock exchange had the fist property developer IPO in a year, the company BBMG Corporation. The issue was oversubscribed by a stunning 235 times at HK$ 6,38 – the first trading price was HK$ 10,20. It belongs to the story that BBMG is not a 100% property developer as they run different production brands as well. Never the less it has supported the sector in general pushing P/E above 10 again and signals more investor appetite for commercial property. The next large IPO is likely to be Evergrande in October and more will follow.

The Chinese government is doing everything possible to fuel the boost. Chinese insurance companies are hungering for investment alternatives as they are limited to a few asset classes like stocks and a small bond market. Early 2009 the Chinese insurance law was revised to include fixed investments like properties. Before a total of only 20 billion Yuan was allowed to be invested in properties. After the new rules get introduced the amount could exceed 300 billion Yuan.

The latest unconfirmed news from end of August are that fund houses and brokerages should be allowed to offer exchange traded real estate investment trusts (REITs). This needs to be confirmed by the China Securities Regulatory Commission.

Yes, it smells of a boost and fast profits, and make my alarm bells ringing. This is an opportunity that needs to be explored, but the investor needs to be very careful.

I can find a number of people who claims that commercial properties already are priced too high. That alone is a risk, but one thing is sure, a lot of unfinished projects and properties without occupation will be sold in different packages.

My conclusion is that it should be explored but the quality is very essential. If it is unsatisfactory, then stay away as the bubble will clear the air one day again..

Production overcapacity is a problem

The Chinese industrial production looks fine and is developing better than the numbers from the old economies. There has been a real turnaround from the slump last year.

That the growth rate never went down in negative territory partly justify the rebound in equities since last autumn. So what is the problem ?

The leaders of the Communist Party have a very good micro and macro economic understanding. The problem is further down in the hierarchy as the main part of enterprises is state owned. The management of corporations across China is heavily influenced by the Communist Party heads of the local provinces. Some of these heads and the corporate managers do not always take economic sinful investment decisions, but compete with the neighbour about being the biggest. The result is overcapacity, apparently so big that China’s State Council chaired by Premier Wen Jiabao intervenes.

Overcapacity in the steel business I mentioned for some weeks ago issue but now is cement, plate glass, coal chemical and wind power equipment added to the list. High-tech and service sectors are said to receive more support.

This is very interesting information as it means a lot for stock pricing in the different sectors. The way to curb sectors with overcapacity is to sharpen the conditions for new approvals but also to tighten credit for the existing business.

I expect the mentioned sectors to underperform compared to other stocks, but it also tells us, that the overcapacity is serious. The wind power sector is worth to notice, where investors throughout the world are upbeat on the sector, does China report about overcapacity.

1st half year results comfort investors

During the last week of August the 1^st half year results from several leading listed companies ticked in. Good and bad, but in general good enough to comfort local investors.

As the only airline company in the world Air China surprised on the upside due to growing demand. China Life and China’s top homebuilder released positive news as well. Below the blue chip size a range of good results was posted as well.

Car producers surprised on the downside where DONGFENG Motor Group didn’t deliver the expected income growth and SAIC Motor was weak as well, a bit surprising and should be noted.

Like in other stock indices are the banks quite heavy. The half year results are ok, but more difficult to judge due to the enormous lending growth. I am not so impressed of the banking results.

During the 20% drop in August foreign investors left the stock market but locals, and in particular private investors, bought around the bottom. It signals local comfort, though from private investors and not from the large accounts with borrowed funds behind.

Regarding the A stock index is the 3050 important, where a close above will be seen as good support. Very important is 2900 as it is watched by all participants in the market.

The August drop was steep but basically just down to more sustainable levels with a domestic average P/E value at 25 instead of 30 at the high. Some sectors are under growth pressure and the speculative money is a risk we need to watch.

The Chinese stock story suddenly has turned somewhat more complicated and I have earlier warned about uncomfortable high levels. Despite the downside risks have increased I can not recommend to leave China stocks yet, but I follow it very closely.

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