SinoInsight 1
China’s A-shares markets rose in the first week of April, with the Shanghai Composite Index gaining 5.04 percent and the Shenzhen Component Index going up by 5.01 percent. During the week, three of four trading days saw the combined turnover for both indexes exceed 1 trillion yuan ($148.855 billion).
The positive gains in China’s stock markets have led mainland analysts to hail the arrival of the “bull market.” Some particularly bullish analysts even sold the positive trends in the first week of April as “the eighth destiny-changing opportunity,” i.e. investors should seize the chance to enter the markets. Analyst optimism appeared to have attracted a fresh wave of investors to the markets, with 2.99 million new brokerage accounts opened to trade in the Shenzhen index in March (up 109 percent from a year ago).
OUR TAKE
1. We wrote in previous newsletters that Chinese stocks are seeing a technical “bull market” that is not reflective of sound economic fundamentals. Put another way, the “bull market” is unlikely to be sustainable and poses high risks for investors.
2. We believe that China’s latest “bull market” cycle is partly a result of the People’s Bank of China injecting liquidity into the markets near the end of 2018. In December 2018, the PBoC’s total assets surged by 1.34 trillion yuan while reserve money-deposits of non-financial institutions grew by 2.13 trillion yuan. Given the central bank’s reserve money-deposits at the time, China’s M2 money supply theoretically grew by 12.78 trillion yuan (money multiplier of 6) in December 2018. And since January 2019, China’s A-shares have rebounded from a historic low (2440.91).
3. While A-shares continue to rise sharply, we have observed that many majority shareholders are reducing their holdings.
According to data from Chinese financial service provider Wind, 857 public companies saw their majority shareholders sell-off a total of 36.6 billion A-shares worth 52.635 billion yuan since the start of 2019. This suggests that majority shareholders do not share the same optimism about the markets as mainland analysts.
4. We believe that the CCP needs the PBoC to keep adding liquidity at a rate that is greater than that of capital outflows to sustain stock market growth. Meanwhile, the rate of capital outflow hinges on China’s economic prospects and confidence in the renminbi.
This year, the RMB rate has stabilized at around 6.7 to the dollar after PBoC intervention. The CCP has two reasons to keep RMB rates stable. First, stock market growth requires a stable currency. Second, Beijing has an interest in sealing a Sino-U.S. trade deal and does not want to give Washington an excuse to punish China for currency manipulation while trade talks are on-going.
To get an idea of what China’s capital outflow situation is like, we can look at the PBoC’s balance of payment data. According to the latest figures, the central bank’s net errors and omissions reached a high of $1.14 trillion from 2009 to 2018 and averaged $203.925 billion each year between 2015 to 2018. In other words, China could be seeing capital outflows of about $200 billion annually.
Per the latest official data, China had $3.099 trillion in foreign exchange reserves in March 2019. However, after accounting for short-term foreign debt obligations, overseas investments in Chinese securities, the sustainability of maintaining imports over the past three months, etc., China’s available balance in the reserves might not exceed $200 billion.
We believe that the PBoC will find it difficult to maintain the RMB rate at a high level (6.7 and lower) if China’s real economy does not see a significant turnaround or if the country is unable to attract substantial foreign investments.
On March 24, PBoC governor Yi Gang said at the China Development Forum that “the central bank has already withdrawn from day-to-day interventions and now more and more market participants are getting used to a flexible exchange rate.” This suggests that the PBoC is planning dial back its stabilization of currency rates and could let the RMB depreciate in the future.
5. If our analyst is accurate, then the A-shares markets will remain highly risky going forward regardless of the outcome of Sino-U.S. trade negotiations.
SinoInsight 2
Recently, publicly listed Chinese banks, including China’s six state-owned commercial banks (Industrial and Commercial Bank of China, China Construction Bank, Bank of China, Agricultural Bank of China, Bank of Communications, Postal Savings Bank of China), released their 2018 annual report. The six banks issued 5.13 trillion yuan worth of new loans last year, of which 2.53 trillion yuan (49.39 percent) were personal housing loans.
Personal housing loans accounted for more than half of the new loans made by CCB (61.45 percent) and the ICBC (54.9 percent). Meanwhile, personal housing loans made up over 40 percent of the new loans issued by the BOC (49.6 percent), the ABC (43.2 percent), the PSBC (40.6 percent) and the BoCom (40.1 percent).
The official home loans data of the six banks do not account for the possible diversion of other consumer loans to the property market via various channels.
OUR TAKE
1. The above data shows that over 50 percent of bank loans have gone to the property market. This creates a serious crowding out effect in the real economy and greatly weakens consumer spending power.
The profits of the six state-owned banks exceeded 1 trillion yuan, or 15 times that of China’s leading property developer Evergrande. In 2018, 1,617 small and medium-sized public enterprises generated profits totalling 266.1 billion yuan (down 32.9 percent year-on-year), or 31.5 billion less than ICBC’s profits (297.676 billion yuan).
2. China’s property market began showing signs of recovery in March after several regions relaxed property price limits or restrictive property and household registration policies. This indicates that the CCP regime is resorting to the old trick of stimulating the economy by raising property prices. However, this trick does little good for the real economy and heightens property bubble risks.
3. We are not optimistic about how China’s economy will fare in 2019. In our China 2019 outlooks, we predicted continuing corporate closures and rising unemployment. If the economic downturn does not show clear signs of reversing, the property market may run into low supply troubles which will in turn increase financial risks in China’s banking system.
