- Chinese stocks have been a terrible investment in recent years. However, that may be all about to change.
- All mainland stock indexes have rallied more than 20% from their recent lows, leaving them in a technical bull market.
- Large daily gains are not uncommon, trading volumes are soaring and margin debt is starting to increase — it feels just like the early days of the massive bull market in Chinese stocks that began in 2014.
- That bull market blew up in spectacular fashion a year later. However, Nikko Asset Management believes this bull market is different.
- It believes this could be “the new beginning after a lost decade”.
After a rough few years, the outlook for Chinese stocks is looking a whole lot brighter.
Thanks to an easing in trade tensions between China and the United States and fiscal and monetary policy stimulus from policymakers, Chinese stocks have taken off in recent months with all major mainland indexes currently up more than 20%.
Yes, the bull market in Chinese stocks is back.
Large gains most days are not unusual, trading volumes are surging and margin debt is making a comeback — it feels just like it did in the early days of the bull market back in 2014, something that saw the benchmark Shanghai Composite Index soar over 160% in a little over a year.
As many observers at the time noted, that bull market seemed a little unsustainable, more akin to a government-endorsed buying frenzy that was always destined to pop. Momentum, rather than fundamentals, was clearly in the driving seat.
In the end, the bubble not only deflated but popped with a bang, leaving policymakers, and authorities including the police, to take extraordinary measures in an attempt to stop the carnage.
Arresting short-sellers, anyone? Or making university students chant phrases praising the merits of investing in stocks? They were just two of the more unusual stories heard at the time.
Ever since, Chinese stocks have performed terribly, especially last year, falling into a bear market, or a bear market within a bear market, depending on who you ask.
Semantics aside, it’s been a terrible run for Chinese stock investors.
Until recently, that is.
With Chinese stocks powering higher, many are asking whether this is just the start of another boom-bust cycle that’s been seen so often in the past.
While opinion will naturally differ, Truman Du and Rob Mann, Portfolio Managers at Nikko Asset Management, believe the rally this time is different.
They believe the rally will be sustainable on this occasion, thanks in part to another asset bubble that exists in China: the property market.
“We believe that Chinese stocks, which have rebounded strongly of late, could trend higher on a sustainable basis,” they wrote in a research report, adding “there are several reasons that could lead to a re-rating in these equities”.
“Firstly, China’s property bubble could be nearing its peak.
“China’s top leaders realised the dangers of runaway property prices two years back and have since taken efforts to manage the country’s real estate prices more carefully.
“If the cooling of China’s red hot property market is successfully maneuvered, the resources of the government and capital of families will gradually flow out of real estate”.
So a potential switch from property to stocks could act to push the latter higher.
However, that’s been seen before, so what makes this time different?
Du and Mann say that’s not the only factor working in the favour of stocks on this occasion.
Again, they’re linked to two areas that China is renowned for: high levels of indebtedness and unproductive or unnecessary investment.
On the former, Nikko says China’s debt binge to spur economic growth is “unlikely to continue”, meaning the country will have to rely more upon direct financing, via its equity and fixed income markets, to “fund its businesses and economic growth initiatives”.
“That will be a big positive for China’s equity market,” Du and Mann say.
They also believe overinvestment in specific sectors is unlikely to continue, providing another tailwind for stocks.
“Smaller amounts of capital should yield higher returns, particularly as the authorities are encouraging lending to be directed to the private sector,” they say.
“An entrepreneurial mind-set in a strongly growing economy without irrational competition is a very positive combination for equity markets.”
And while retail investors have driven boom-bust cycles in the past, Nikko says the opening up of Chinese financial markets, allowing offshore investors to participate, should see Chinese markets “mature and trade in line with fundamentals”, an outcome they suggest will help to “reduce volatility and allow good companies to outperform”.
Along with a shift from policymakers towards a more sustainable economic model, and likelihood that private Chinese companies will have easier access in tapping equity funding from within China, Du and Mann say this could be “the new beginning after a lost decade” for Chinese stocks.
“That’s why we are confident that returns for onshore China equities will be much better going forward after underperforming over the past decade,” they say.
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