Don't write off China equities just yet

Don't write off China equities just yet
PHOTO: Don't write off China equities just yet

CHINA - Just a few years ago, China looked invincible.

Even when the US sub-prime crisis erupted in August 2007, hopes that the mainland would relax its strict capital control to allow its citizens to invest in overseas equities kept the Asian markets buoyant for a few more months before the appetite for equities soured.

It enabled the benchmark Straits Times Index (STI) to hit a record high of 3,831.19 in October that year.

But the region-wide rally was stopped in its tracks by China's decision to put the overseas equity investment scheme on the back-burner the following month and it has stayed there ever since.

Fast-forward a few years and people no longer seem to be enthralled by the China story. A sudden credit crunch caused the Shanghai stock market to crash an eye-popping 5.3 per cent in a single day last month.

Old arguments have been dredged up to support the case against investing in China equities - that its people are a demographic time-bomb which will grow old before getting rich, that they are saddled by a gigantic shadow banking sector resembling a giant Ponzi scheme and that the frothing real estate bubble might just burst any time.

Even news on the economic front has not been encouraging. On Monday, China reported that its second-quarter gross domestic product (GDP) growth slowed to 7.5 per cent, weighed down by weaker exports and faltering investments.

And it would appear that China's growth may slow even more - its finance minister, Mr Lou Jiwei, made a Freudian slip at a news conference in Washington last week when he said he expected 7 per cent growth this year.

This is well below the official growth target of 7.5 per cent.

Not surprisingly, it has led to a souring of the decade-long love affair with China equities. As Citi Investment Research strategist Markus Rosgen observed in a note, as of last week, foreign investors were taking money out of China shares even as they were adding more equities to their portfolios elsewhere.

He said: "On a year-to-date basis, all Asia funds had a net outflow of US$2.1 billion (S$2.7 billion). China funds alone contributed US$3.8 billion to the outflow (and more than offsetting the inflow into other funds)."

But a slowing China economy would have a much bigger impact on the region's stock markets compared to the previous bouts of slowdown experienced in the past two decades.

Take the STI: Its component stocks include CapitaLand, whose China and Hong Kong properties make up over one-third of its assets, and CapitaMalls Asia, which owns malls in China.

Then there are the giant plantation firms Wilmar International and Golden Agri-Resources, commodity supply chain manager Noble Group and port operator Hutchison Port Holdings - all of which have big exposure to China.

Among the Singapore banks, greater China loans, excluding Hong Kong, make up about 16 per cent of DBS Group Holdings' loan book. Greater China loans make up 11.4 per cent of OCBC Bank's loan book and 5.3 per cent at United Overseas Bank.

So, one worry is that hedge funds may use the STI, along with other indexes with big China exposure such as the Hang Seng, as proxies to "short" China if the Chinese economy slows down further.

On the flipside, however, it can be argued that investors are over-reacting to the slower growth and structural problems in China. These problems may have been fully priced into the depressed stock prices already.

Some analysts observe that far from panicking, the new leadership in Beijing may actually welcome the slower growth as it tries to move the Chinese economy away from being dependent on investments and towards a more sustainable consumption-led model.

The big job ahead for Beijing is to ensure that the current slowdown does not turn into a rout as companies are squeezed for cash because they relied on the shadow banking sector for capital, which is no longer available to them because of the credit crunch.

US markets writer Jim Jubak, for one, believes that barring a big mistake made by a big Chinese bank in derivatives, the chances of a China credit crunch turning into a global financial storm are remote.

"I think getting China's storm to escalate into a global storm would require a big drop in China's GDP growth and the collapse of a significant European government. Even in this worst-case scenario, I don't think we get a replay of Lehman Brothers and the global financial crisis," he wrote.

engyeow@sph.com.sg


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