However, given that foreigners are heavily restricted in their access to the A share market and given that they tend to avoid the types of shares that Chinese retail punters like to buy so heavily on margin, and which have been sold off so aggressively, does it really matter?
The Hong Kong markets has behaved as though it does, but maybe that's understandable: the Hang Seng Index topped out at 28,433 on April 27th, whilst the H share index reached its peak of 14,812 on May 25th. The former is now down 14% and the latter by 25%. Broader non-Japan Asian markets are now also down for the year.
The background to the Chinese market's travails lie mainly with restrictions on margin lending that were introduced, somewhat heavy handedly, in May and early June. Since then, the government has been doing all it can to reverse much of these, in the interests of offsetting incipient panic. The jury is still out as to whether or not its efforts will work: the PBOC has trotted out the now well-used global central banker's mantra of being prepared to do "whatever it takes", and we note that a stable stockmarket is an important factor behind China's efforts to promote further market based reforms. Alternatively, are they just postponing an inevitable further sell-off?
It is clear that investing in China brings both risks and opportunities.
The risks lie in the relatively short experience of Chinese investors with stockmarkets, the lack of any focus on (or indeed interest in) "fundamentals", the focus only on short-term leveraged driven trading, and the shortage of a well developed institutional investor base. All of these cause market movements to be unduly magnified. It's all about momentum.
It's for this reason that most foreign investors focus on the bigger picture and focus on investing in those companies that give access to that bigger picture. For them, the current sell-off provides the proverbial buying opportunity.
Andy Rothman, the well respected strategist at Matthews Asia, notes that the market did not fall because of macro problems (and indeed the correlation - globally - between GDP growth and stockmarket performance is pretty low), even with GDP growth likely to fall to between 5% and 6% by 2020. Although corporate debts in China have been rising, these are concentrated among state-owned firms, whilst - according to Matthews - "the private firms that generate most of China's new jobs and investment have already deleveraged. China's foreign debt... is less than 10% of GDP".
Andy also notes that the rise in residential property prices and property supply that many investors fret so much about (with all those vacant units in secondary cities) occurred at the same time as a 12% rise in average annual urban income growth. He notes also that Chinese buyers are not over leveraged - in contrast to the position in the US and elsewhere in the run-up to 2008/9 - since they all need to put down a deposit of 30%.
We then come down to value: note that the H share market in Hong Kong is now trading at a forward PE of around 8x, vs. 15-16x for the comparable A shares in Shanghai. H shares underperformed the A's on the way up, and now that dynamic is reversed on the way down. UBS certainly feels that the market has been oversold: they have a floor for the H share index of 10,800 (3% below current) and one of 2,600 for the SSE (30% below current). They also note that with the central bank pledging liquidity support, the CSFC has theoretically unlimited buying power (it's just that this has not been fully unleashed).
So - we therefore have a gap between steady fundamentals in the H share market and market sentiment driven by the A share collapse. At the moment, the risks are essentially binary... either the government delivers on its "whatever it takes" commitment, and the market recovers, or it doesn't, and margin related selling takes it further down.
This is not a great environment for making objective investment decisions.
However, in principle, we like the H share story, feel that valuations are even more attractive and like managers that focus on good companies that will participate in China's structural and consumer led growth over the next decade. These would include insurance companies that cater to the rise in demand for basic life insurance and health care products in China, and some consumer goods businesses.
Bear in mind that in our portfolios, though, China accounts for about a 3-5% weighting, and we're comfortable with maintaining that at present. This is what a sensibly diversified portfolio strategy is all about.
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