China bear growls loudly

UOBKayHian: In the global ranking for the first quarter of 2008, China’s stock markets had the dubious distinction of being the worst performers among major bourses. The Shanghai A-share market had plunged 34% ytd from its mid-October closing high of 6,396 points. The percentage loss was bigger, at 43%.This must be inexplicable to the casual follower of the China markets, considering that the Dow Jones Industrial Average (DJIA) only lost 8% ytd and 14% from its 52-week high. Is there room for the DJIA to fall further, as the US is now facing a recession and is at the epicenter of the financial tsunami sweeping the world ?

On the surface, the ongoing correction in the China markets is not exactly surprising. Last year, irrational investor euphoria fuelled valuations to ridiculous levels of over 40x last year. Today, the Shanghai A-share market is trading at about 20x 2008 earnings, against about 40x last year. So, is a bottom in sight? Investor sentiment is so negative such that unless Beijing steps in to do something meaningful and quickly, fear it may prove as hard as it was in 2000 to rev up the market ahead of the 2008 Olympics.There is speculation that China will cut the stamp duty on stock transactions. But we believe the key to any successful intervention must be an assurance on the issue of turning non-tradable state shares into tradable shares. In late-05, Beijing launched a state share reform plan, which ignited a massive share rally all the way into Oct 07. The plan allows the state’s shareholders to make the state shares tradable with a lockup period of up to three years. The year 2008 will see the peak of the expiry of the lockup period. The total number of untradable A-shares is about 1.6t – more than 3x the existing supply of tradable A-shares.Unless the bulk of it is channelled to the state pension fund, the China markets will have no choice but to give the growling bear a reluctant hug.

MyTake: It is of China's interest to save its stock markets. Of late, the market confidence has probably reached its lowest. This was worsened since China is undergoing a monetary tightening policy for the last 18 months. It is evident that in order to lift the market out of its doldrum, the Chinese authorities have in recent times approved many QFIIs which were not easily approved 6 months ago. Remember also previously, raising stamp duty was a way to lower the appetite of investors, now the reversal is seen. Further, the "through train to HK" program has probably been shelved although the Chinese are denying it. It was the hope that all local funds stay local. I would say the probable buying of untradable A-shares by state pension funds is one of a major catalyst for the Shanghai/Shenzen Stock Exchanges to propel upwards again.