Mainland buyers don't share enthusiasm for China shares

Offshore investors have poured billions into mainland equities but the homegrown punters are sceptical, and they may have a point

PUBLISHED : Wednesday, 28 November, 2012, 12:00am
UPDATED : Wednesday, 28 November, 2012, 2:34am

Yesterday the mainland's most closely followed stock market index, the Shanghai composite, slipped 1.3 per cent, falling below the 2,000 mark to close at its lowest since the depths of the financial crisis in February 2009.

The index is now down 16 per cent over the last 12 months. To put that drop into perspective, it's a worse performance than either of the crisis-hit markets of Spain or Greece. Over the period, Madrid's benchmark Ibex index has fallen by just 3 per cent, while the Athens ASE index has actually managed to climb 26 per cent.

The latest slump in the mainland market will come as a bitter disappointment both to local regulators and foreign investors in Chinese equities.

Over the course of this year, mainland securities regulators have made repeated attempts to boost China's ailing markets. They have told investors that equities are a bargain, and pressed companies to buy their own stock, even allowing managers to offset the cost by paying employees in shares.

They have restricted the supply of equities by holding back new issues. They have given insurance companies greater freedom to invest in the market. And they have loosened the rules on margin trading, allowing investors to gear up.

On top of that, in a bid to entice more international investors into the local market, they have extended the quotas granted to foreign institutions to buy yuan-denominated shares.

For the most part foreigners have been keen. In the last few weeks a clutch of analysts have noted that China's economic headwinds have reversed, and that there should now be a welcome tailwind.

Lingering political uncertainties have been assuaged by this month's leadership transition.

The authorities have eased their previous tight monetary policy stance and are injecting vast quantities of liquidity into the mainland's money markets.

With Beijing's blessing, infrastructure investment is picking up again. In response leading indicators of growth including HSBC's purchasing managers' index have returned to positive territory.

In such a relatively favourable environment, with China's growth this year on target to top a respectable 7.5 per cent rate, analysts have been quick to point out that valuations look attractive. At a ratio of price to estimated 2012 earnings of less than 10, mainland shares are cheaper than those of any other major market in the world.

Indeed, Chinese equities are cheap even compared to shares in Egypt, where the market has been hammered by fears that mounting political unrest could jeopardise a much-needed emergency loan from the International Monetary Fund.

As a result, offshore investors have turned positive, allocating billions of US dollars to Chinese equities over recent weeks.

Onshore investors remain sceptical, however. With sentiment and momentum firmly negative, local investors are steering clear of the mainland market. In terms of the number of shares traded, transaction volumes are down by 80 per cent compared with three years ago.

And despite the revival of international interest, they may have a point.

Figures released yesterday showed industrial profits up just 0.5 per cent over the year to the end of October. That's an improvement over recent months. But for an economy likely to grow at close to 8 per cent this year, it's a feeble performance.

Nor is there much indication that profitability is set to improve with the upturn in economic activity. The cashflow return on assets of mainland listed companies has shown a pronounced decline over recent years and now stands well below their borrowing costs (see the second chart).

That's going to make it tough to generate healthy earnings growth any time soon. Mainland investors may be right to sit this one out.