The China market rally is basically a huge bet on government policy

Getty / China Photos

Weakening economic growth and increasingly-stretched earnings valuations haven’t impeded enthusiasm for Chinese stocks.

Despite a raft of weak economic data released in recent months they’ve have been on a monumental bull run, rising over 100% in the past year and 40% in 2015 alone.

It seems that despite the deteriorating economic environment, investors – encouraged by the government to invest directly into equities – have been willing to push aside fundamentals in favour of speculating on continued monetary policy easing from the PBoC.

The chart below from Bank of America-Merrill Lynch demonstrates this divergence perfectly. It shows how the price of the MSCI China ‘H’ shares index – Chinese corporations listed in Hong Kong – has risen sharply since the beginning of the year despite company earnings expectations slumping over the same period.

Essentially, even as expected earnings growth deteriorates, stocks are continuing to soar. BoAML suggest it’s the purest example of what they deem to be ‘Max liquidity, minimal growth’ – that expectations for further monetary policy easing from the PBoC are trumping concerns about slower earnings growth.

Indeed, there seems no let up in enthusiasm to buy Chinese stocks.

Only last week the number of new domestic accounts to trade mainland Chinese stocks rose to an all-time record high – represented by the brown line in the chart from BoAML below.

And the surge in stock prices is not only reflective of demand from within China. As this chart from JP Morgan demonstrates, Northbound flows from the Shanghai-Hong Kong stock connect has been steadily rising reflecting ongoing demand for Chinese stocks from Hong Kong.

So while the divergence between company valuations and the broader Chinese economy continues, there is no indication as yet that the bull market in Chinese markets is over. With expectations for further policy easing continuing to grow, it could run for a while yet.

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