In Bull vs Bear, specialists argue opposing views on hot market topics. In this first column, John Woods (Citi) faces off against Gary Dugan (Coutts) over whether mainland equities are a good buy Bear view: unsure onshore … Why on earth should investors avoid A shares, or yuan-denominated stocks that trade in Shanghai or Shenzhen? Recent economic data has been surprising to the upside: valuations are cheap; government policies are supportive; and most importantly, the mainland's retail investors appear to buying again. The mainland's macro data is undeniably improving. Purchasing Managers' Index, an indicator of manufacturing activities, has ticked up above the (expansionary) 50 level; inflation remains benign; and Thursday's strong export trade data shot the lights out. But assuming economic growth goes hand-in-hand with market gains is a classic investor error. Since 2008, the mainland's economy has expanded (in nominal terms) by a staggering 110 per cent; the Shanghai Composite, conversely, has contracted by 58 per cent. Valuations are critical, of course, and on that basis the mainland's onshore market is one of cheapest in the world, with a price-earnings ratio in the high single digits. But as Japan has long taught us, what is cheap can become cheaper still. The mainland is cheap because of entirely underwhelming earnings which, as of the third quarter of 2012, were contracting by 2.2 per cent year on year and by 1.1 per cent quarter on quarter. Profit rather than valuations drives investor behaviour. Mainland authorities have been rolling out shareholder-friendly initiatives. Regulators said they would instruct and check underwriters and auditors of companies looking to list to ensure their financial documents were accurate. Unfortunately, this measure comes amid almost daily examples of accounting irregularities or outright fraud. Moreover, according to official records, some 800 firms have applied for an initial public offering on the mainland. This nearly insatiable demand for cash means issuers will keep pumping money out of the A-share market before any rally has a chance of taking off. As long as this liquidity overhang remains in place, it's hard to get too excited about a rally. Indeed, given the market's 16 per cent-plus rally over the past couple of months, and the still uncertain global macro backdrop, investors would do well selling now, thereby locking in profits, particularly among names in the more risky sectors such as property and insurance. John Woods, chief investment strategist, Asia-Pacific, Citi Private Bank Bull view: return of retail We expect double-digit returns from the A-share market in 2013. The forward price-earnings ratio for the CSI 300 Index, a benchmark, is about 10.5 times - well below the post-crisis high of 24 in July 2009 and the pre-crisis peak of 34 in 2007. The CSI 300 Index is expected to deliver solid earnings growth of 16 per cent for both 2013 and 2014, based on Bloomberg estimates. A shares appear to have recently reversed their three-year slide, and we think this strong rally is sustainable given a supportive economic backdrop. Tellingly, we are seeing signs of renewed interest in equities from mainland retail (individual) investors, who dominate the trading and valuations of this market. Until recently, retail investors were grappling with the shell shock of 2007's sell-off, when the A-share market dropped an eye-watering 72 per cent. The event fed a mood of profound apathy, with A shares shedding 44 per cent of value between 2009 and the fourth quarter of 2012 in a climate of dwindling turnover and gloomy headlines about the mainland's economic outlook. But investor confidence appears to be gradually coming back. The evidence for this can be found in the increase in the volume of stock account openings and generally in rising trading volumes. Our view is that mainland stocks are cheap on their fundamentals (firms' profits and growth), and that the fundamentals will lead investors to more optimistic view of this market. Indicative of the new mood, institutional investors drove the recent rally in Hong Kong-listed mainland stocks (H shares), and they were acting on evidence of improved economic data. The mainland story is all about a rising middle class which is catching a tide of rising wages, and which is itching to spend to raise their material standard of living. It's a compelling investment story. It is this middle-class economic evolution that will inevitably drive A-share prices forward, regardless of the periodic swings in sentiment. Gary Dugan, chief investment officer, Asia and Middle East, Coutts
