China economy and share markets at crossroads
Analysts and economists differ greatly on the future of the stock markets as the economy slows and the change of leadership looms
The last time the mainland's stocks were this cheap, in 2008, the benchmark index rose 83 per cent in a year. Now is different as policymakers struggle to reverse the worst economic slowdown in more than a decade, the most accurate strategists say.
While the Shanghai Composite Index trades at 11.4 times the earnings of the biggest companies, the lowest level since at least 1997, economists predict the economy will grow at its slowest annual pace in 13 years. Investors anticipate the government will lack focus on the slowdown as the Communist Party prepares for a leadership transition.
Haitong Securities strategist Chen Ruiming, who correctly predicted on August 1 that the index would fall below the 2,000-point level, says the measure is poised to drop a further 14 per cent to 1,800 points this year.
Bank of Communications analyst Hao Hong says the markets will end down for the third successive year. He was the only forecaster among 13 strategists surveyed by Bloomberg at the start of the year to predict declines for equities this year.
Falling interest rates and rising copper prices - which foreshadowed the rally in 2009 - are not predictive this time around, says David Cui, the chief China strategist at Bank of America. He sees more losses for the index after saying in February that it would slump to 2,100 by the end of this year.
The index closed 5.68 per cent lower at 2,074.42 points yesterday.
"These signals are only indicative of a market turnaround if and when there are signs of a genuine turnaround in economic growth and the prospect of sustained improvement in corporate earnings," Cui said.
"Right now, things appear to be still heading downhill and the market cannot figure out where the bottom is."
The Shanghai market's price-earnings ratio has dropped to 11.4 from an average of 24 in the past decade and a 2007 high of 46. The MSCI Emerging Markets Index is valued at 12.6 times profit, while the Bovespa index in Brazil, the second-biggest emerging market after China, trades for 18.8 times.
Jonathan Garner, the chief strategist for Asia and emerging markets at Morgan Stanley in Hong Kong, sees "significant undervaluation" on the mainland and recommends material, energy and consumer discretionary stocks that will benefit from the largest economies in the world easing monetary policies.
Jim O'Neill, the chairman of Goldman Sachs Asset Management, says Chinese stocks are the most attractive among the developing nations group of Brazil, Russia, India and China as Beijing fosters changes to boost consumption and reduce the economy's reliance on exports.
"People are underestimating the micro policies to improve the health of the consumer, including the development of a health-care system and a pension scheme," O'Neill said. "For the bold, buying China equities, particularly consumer-facing, is a very interesting thing to do."
Bears say the new government will not change enough to make shares attractive.
Data for the past two months points to a deepening slowdown after manufacturing contracted last month, imports unexpectedly fell in August, industrial output expanded at its weakest pace since May 2009 and industrial profits dropped for a fifth month. Policymakers cut the expansion target to 7.5 per cent from 8 per cent goal, Premier Wen Jiabao said on March 5.
The mainland's economy might grow at a 7.7 per cent pace this year, according to the median forecast of 45 economists in a survey, which would be the slowest rate since 1999.
"The economy will still be down," Chen said. "The only way for the market to improve is to allow a natural adjustment within industries; allow for companies to restructure, be acquired or go bankrupt."
The People's Bank of China reiterated last month that it would pursue a "prudent" monetary policy, dampening speculation of interest rate cuts, while Xinhua said last month that "massive stimulus" would be detrimental to growth.
Since 1996, the Shanghai Composite Index has advanced nine times out of 13 in the three months after the central bank lowered borrowing costs. The index jumped 17 per cent in the three months after a December 2008 rate cut. This time, the index has fallen 9 per cent since June 7, when the government announced the first of two rate reductions. The combined drop in deposit and lending rates is 56 basis points.
Cui said investors needed to see the government tackle the fundamental issues, including reforming state-owned enterprises and the tax system.
"I don't think stimulus or loosening is the path to investors' heart," he said.