Across The Border

China’s large-cap share rally shows signs of faltering

Measure of the 50 biggest companies on the Shanghai Stock Exchange drops 0.8 per cent so far this month

PUBLISHED : Wednesday, 13 September, 2017, 1:42pm
UPDATED : Wednesday, 13 September, 2017, 9:55pm

China’s bigger companies, the darling stocks for traders this year, are making a shaky start into September.

A measure of the 50 biggest companies on the Shanghai Stock Exchange has dropped 0.8 per cent so far in September, while the benchmark Shanghai Composite Index and the ChiNext gauge of smaller firms have both notched up gains in the period.

An 18 per cent advance on the SSE 50 Index this year has made valuations less attractive. Another risk is the corporate earnings outlook may turn bleak amid a possible slowdown in economic growth, according to Jingxi Investment Management and KGI Securities.

The underperformance may signal the end of the rally in large Chinese companies after a government-led clampdown on financial leverage prompted investors towards the relative safety of the nation’s biggest companies with cheaper valuations. The average valuation of the 50 biggest companies on the Shanghai bourse recently hit a two-year high, according to data compiled by Bloomberg.

“They are low-valuation and low-growth companies,” said Wang Zheng, Shanghai-based chief investment officer with Jingxi Investment. “Once the valuation increases significantly, the big-caps are losing much of their appeal.”

New China Life Insurance and China Galaxy Securities, both of which retreated 5.9 per cent as of Tuesday’s close, led the declines among companies comprising the SSE 50.

The SSE 50 is now trading at 12.3 times reported earnings, almost equal to its prior peak in June 2015, Bloomberg data showed.

Earnings for bigger companies, many of which are in cyclical industries, may weaken for the rest of the year, as recent economic data point to a looming soft patch, says Ken Chen, a strategist at KGI Securities in Shanghai.

China’s industrial production, fixed-asset investment and retail sales all trailed analysts’ estimates in July after the economy expanded at the fastest pace in almost two years in the second quarter.

“Large caps’ earnings are closely related to the macro economy so that’s why we see earnings improvement in the first half,” said Chen. “The third-quarter GDP will have sort of slowdown as apparently there isn’t any recovery in the September data. So that’s not conducive to large caps’ earnings.”

The constituent companies on the SSE 50 posted 10 per cent profit growth on average in the first six months, according to data compiled by Bloomberg. For the full year, earnings growth will cool to 6.7 per cent, the data showed.

Analysts recommend switching to smaller companies, citing valuation and improving outlooks amid a possible improvement in credit conditions.

After a two-year decline, the ChiNext index of start-ups is now trading close to its cheapest level against the SSE 50 Index in terms of price to earning , Bloomberg data showed. The ChiNext index has rebounded 1.9 per cent in September.

Still, Shenwan Hongyuan Group, the brokerage that was ranked third industry wide for equity strategy research by New Fortune Magazine last year, prefers bigger companies over smaller firms, because of a rebound in producer prices in August.

``The data are an important signal and it means that earnings growth for mainboard companies may still remain robust,’’ said Wang Sheng, a strategist at the Shanghai-based brokerage. He recommends buying bigger cyclical companies, including steel, aluminium and financial stocks.

Prices in industrial goods rose 6.3 per cent last month, accelerating from a 5.5 per cent increase in July, as the government’s campaign to eliminate unneeded capacity in traditional industries pushes up metals prices.

Buying seems to have already rotated to smaller companies with growth potential. Companies linked to new-energy vehicles are among the best performers this month after a vice-minister of industry and information technology said early this week that the nation is studying a timetable to phase out production and sales of cars powered by fossil fuels.

Shares of Beijing Easpring Material Technology, which makes cathode materials for lithium batteries, had surged 32 per cent through Tuesday this month, while Jiangxi Ganfeng Lithium, a producer of lithium metal, had jumped 31 per cent.

KGI’s Chen says smaller firms are likely to stage a valuation expansion for the rest of year, benefiting from improving liquidity as policymakers ease the deleverage campaign.

“Pretty tight liquidity led to crowded trading in big-caps in the first half of the year,” he said. “Going forward, liquidity wont’ be as tight as the first half and that’ll be good to small-caps.”