The Sound of Silence: A Volatility Flare
China policy tussles: Shanghai is once again swayed by a series of contradicting messages from the top. There appear to be varying views on growth and monetary policies, with one school targeting 7.5% as the minimum growth, while the other is quite relaxed about the attainability of the magic number. At a time of significant property slowdown and investment growth losing steam, which school eventually prevails will determine how stock market confidence will be shaped. In a surprising CCTV News broadcast, the focus on sustainable growth and scientific economic management was reinforced. A number of prominent economists, as well as the PBoC governor, attended the meeting.
In our view, relaxing restrictions on property purchasing, reintroducing discount mortgages or even further monetary easing are likely, given the importance of the property sector in the economy and its multiplier effects. No one is willing to be held responsible for an ugly crash of the bubble. This is one certainty amongst the many uncertainties that the market is facing. But nor is anyone willing to inflate the property bubble further. As such, the scope of policy responses will likely be limited, and will be barely enough to offset the slowdown. In a market where there is a general lack of conviction from the policy makers to market participants, investors are hard to come by, and everyone is a swing trader. Such mentality makes it difficult for bulls to hold onto long positions. Meanwhile, the bears are also coy, as they know full well that the slowdown will not be allowed to degenerate into a free fall. To jolt the market out of its current narrow trading range, something more drastic must happen.
This is in contrast with some previous memorable incidents when the CNY experienced sudden depreciation during talks with the US, most notably during Paulson’s visit in 2008. Exports and forex fund position with PBoC, however, surprised on the downside. The export data suggest the country’s ability to earn foreign currency has weakened. And the market’s expectation about CNY depreciation appears to be difficult to revert after the episode of rapid depreciation in March. Regulators have been busy stemming the potential loopholes of capital expatriation through banking products. In short, the pressure for a small CNY appreciation in the near term is likely, and can act as a stabilizer when market volatility flares up.
Market sentiment very elevated; continue to stay clear of small caps: Overnight, the overseas markets were brought down by bad European data – Italian IP fell unexpectedly; French inflation and production were much worse than expected; and Japanese machinery orders posted a terrible 20% drop. Of course, the Fed has finalized the conclusion of QE in October. With US economic numbers delivering positive surprises but wage pressure rising, the date of interest rate hike has been brought forward. These are all important catalysts for a correction. Investors should take note. Already, we have seen momentum and growth stocks plunging in the past few days. And more will come.
Since our second half outlook “The Sound of Silence” (a preview on June 17 and a full report on June 25, 2014), we have been advocating a defensive stance in anticipation of an impending overseas market volatility event around mid July in our public lecture at the CEIBS, press conferences and investor meetings. We note that market sentiment now in both HK and ChiNext is very elevated (Focus Chart 1-3). It is foreboding, whenever there is excessive joy.
Focus Chart 1: Hong Kong market sentiment is very elevated, and is foreboding.
Focus Chart 2: ChiNext sentiment is very elevated, and is foreboding.
Some take comfort in the improving lending statistics. But such improvements are more likely the result of off balance sheet financing moving back onto balance sheet due to regulatory changes. As such, total social financing growth may not be consistent with lending growth. While there are signs of growth stabilizing, such as narrowing PPI, improving PMI and IP, electricity and thermal coal consumption growth is slow; steel factories are reluctant to restock due to an uncertain outlook; copper prices have run ahead of their low inventory level due to investigations into copper financing; rebar prices are weakened by the ailing property sector; new property construction has plunged but completion is on the rise, adding to inventory; and property investment continues to decelerate, most likely because of developers’ cash flow constraints. Industrial metals have been strong because they represent a better bet on the Chinese economy than stocks, and should hardly be taken as a cue to positive outlook. In short, growth has stabilized but a strong recovery is unlikely. Yet consensus is getting bullish, making growth sensitive stocks and small caps vulnerable to a fall back to reality.
The author is managing director for research at Bank of Communications. Follow him on Sina Weibo.