Bottom of the Chinese stock market? Look towards 1600
When it rains, there are no cabs to be found. One of China’s worst export growths in recent history has unveiled the extent of the RMB carry trade. Meanwhile, weak loan growth, coupled with continuing PPI deflation, suggested slowing economic growth and weakening demand for the world’s second largest economy.
Pundits who are still debating whether the RMB depreciation is a PBOC initiative should look no further than the RMB mid rate, which has been guided lower consistently. A weak and volatile RMB, as I wrote in an earlier column, paints a bleak picture of fundamentals and destroys the RMB carry trades.
Since late last week, I have observed consecutive limit-down days on copper and iron ore, of which structural financing margins are being called and the supply picture is worsening. Iron ore tumbled another 8.3 per cent overnight on Monday - the second worst one-day plunge on record.
Market selloff was further aggravated by the mysterious disappearance of a Malaysian Airlines flight to Beijing on March 8, with 154 Chinese passengers on board. Many now suspect a hijacking or terrorist attack. Outside the restive region of Xinjiang, there have been very few known direct terrorist attacks against Chinese targets in recent history. An attempted attack on March 7, 2008 onboard a China Southern Airlines flight was foiled by the crew. But the bloody knife attack in Kunming less than two weeks ago, and now a missing flight, are something else. As market dislocation grows, traders’ mantra is to sell first, and ask questions later. Without much resistance, the Shanghai Composite Index broke through the supposedly strong support level of 2000 on Monday.
Such violent market moves, concurrent with increasingly louder calls of “market bottom”, are reminiscent of the days in August and September of 2008, when the Chinese market was in its final accelerated downfall. By then, many had started bottom fishing, as it was widely believed Beijing would intervene before the Olympics, if just for appearance’s sake. Also, Shanghai had fallen more than 50 per cent and was clearly oversold. But in September, Lehman Brothers fell and was considered the sacrificial lamb of the financial crisis. Even foreign governments were stepping in to stop naked shorts. Yet, the Chinese stock market fell another 40 per cent before it finally settled.
I have been travelling a lot lately and speaking to many investors. As the selloff aggravated, I was asked at what level the market would eventually bottom out. After all, the 2000-point support level of the Shanghai index has been breached or touched upon on three different occasions in the last few years - December 2012, June 2013 and January 2014. In each of these cases, the market somehow rebounded. But each rebound was weaker than the previous one, with lowering peaks. And other key indices such as copper and iron ore futures, and the performance of cyclical sectors, have all pierced previous technical supports levels – I seem them as the proverbial last straw on the camel's back.
If I must put a number on the ultimate bottom, I'd like to compare individual stocks' valuation at each of the previous market bottoms in 2005 and 2008 with its current valuation, and then weigh it with the corresponding market cap. I find that currently the Composite’s valuation, with its current constituents, is still 15-20 per cent too high relative to the previous bottoms. If so, the bottom range should be around 1,600-1,800, depending on how bad it gets. This is only a rough estimate – we know. And banks are indeed cheaper than they were at previous bottoms. If banks’ valuation fails to hold, the bottom range can be even lower.
Some pointed out that a few initiatives, such as T+0 trading for blue chips and preference shares, are being discussed. I would caution that T+0 will only magnify trading volatility, and preference shares in fact increase companies’ funding costs. These gimmicks will do nothing to arrest the decelerating growth.
Incidentally, banks are finding it difficult to attract deposits, and their lending ability appears to be impaired. Meanwhile, the PBOC seems to be mopping up liquidity and continuing to rein in shadow banking activities. Even after Chaori’s default, sentiment is still far from the point of catharsis. In a risk-averse environment, government bonds will continue to attract funds away from risk assets, and yields will likely head lower (Focus Chart 1).
I have been cautious for some time, and started to sound like a perma-bear. Some would argue that bears are irrelevant in a market which one cannot short easily. There will be fleeting technical reprieves as usual. But for now, I'd be prepared for the worst, and saving my best for last.
The author is managing director for research at Bank of Communications. Follow him on Sina Weibo.