image

China stock market

ChiNext stocks rebound at double the rate of benchmark, but investors see short-lived rally

Bocom and Haitong analysts warn that ChiNext market is still outside the safety margin for investors

PUBLISHED : Monday, 22 May, 2017, 4:23pm
UPDATED : Monday, 22 May, 2017, 10:50pm

China’s ChiNext index of smaller firms may have rebounded at double the rate of the nation’s benchmark since financial regulators signalled a softer stance on deleveraging, but the rally has only convinced investors that it is a good time to sell.

Since mainland stocks bounced back on May 11, the gauge of small-caps on the Shenzhen exchange has risen as much as 6.2 per cent, beating the 3.4 per cent gain on the Shanghai Composite Index of larger companies.

Still, the outperformance is not enough to reverse the bearish views of analysts from Bocom International Holdings and Haitong Securities, who say the board is still outside the safety margin for investors.

China’s ChiNext stocks are cheap, but not enough to buy

“ChiNext is still not a buy. Valuations are expensive,” said Hong Hao, head of research at Bocom International, the Hong Kong-based brokerage unit of Bank of Communications. Hong, who correctly predicted the boom-to-bust of mainland stocks in 2015, said the ChiNext index may decline about 16 per cent from current levels as the rebound is likely to prove to be short-lived.

Mutual fund managers trimmed their holdings in ChiNext companies in the first quarter, as valuations were three times more expensive than the Shanghai Composite even after the small-cap gauge remains 56 per cent down from its 2015 peak. The stretched valuations of smaller firms have prompted investors to seek safe havens in cheaper and larger companies with stable earnings growth, with shares of liquor giant Kweichow Moutai and home-appliance maker Gree Electric Appliances reaching record highs this year.

The probability of positive returns from ChiNext stocks over the next year is almost half that of buying shares on the Shanghai Composite, according to Xun Yugen, a strategist at Haitong Securities, who based his argument on the median price-to-earnings ratios of the two boards.

Chart of the day: Upside potential in ChiNext

The ChiNext index is valued at about 63 times the median PE ratio, well above the 40 threshold considered as the safety margin, while the Shanghai Composite is close to the multiple of 30 times which is perceived as the dividing line between safe and risky, Xun said in a research note.

The ChiNext board has been falling out of favour among investors after the stocks led a crash in mainland equities in 2015 following the regulatory clampdown on margin trading funded by illegal non-brokerage institutions. Trading has been lacklustre since then, with daily turnover down almost 70 per cent from the all-time highs in 2015.

The recent rally appears to be driven more by technical factors than fundamentals, as it followed the index’s decline to a level lower than the nadir in 2015, prompting some buyers to believe the market was over-sold and would see a quick rebound.

A true and sizeable rebound in ChiNext stocks may come in the third quarter, when the ruling Communist Party reshuffles the top leadership in its plenary congress and the pace of financial deleveraging moderates further, according to Chen Li, a strategist at Credit Suisse Group.

business-article-page