ETF Securities Equity Research – The good, bad and ugly of Chinese markets
Summary
China’s macroeconomic indicators are signalling a positive inflection point, however the debt overhang highlights a looming risk.
China needs to maintain the balancing act between its new consumption led economy and slowing investment driven economy to stem the pace of credit expansion.
Chinese stock market valuations are disguised by low earnings multiples of the state owned financial sector.
Greater transparency and clarity of communication about policy is the only way to draw international investors back to the Chinese Equity markets.
Green shoots emerging
Following a challenging start to 2016, official macroeconomic data released by China, ranging from GDP, fixed asset investment, industrial production and retail sales (led by auto and internet sales) are now suggesting that the economy may in fact be at an inflection point. A concerted government effort to restore growth in the real estate sector via cuts in mortgage rates, down payments and a surge in lending has driven a rebound in housing sales. Rising ‘floor space started’ has also provided evidence that growth in construction is catching up. Overall business activity in China expanded for a second straight month in April albeit at a slower pace than March. The rate of new orders growth was the strongest seen in three months. (click to enlarge) Clearly a domestic consumption driven economy is trying to fill the gap left behind by manufacturing activity. While an uptick in the majority of the macro indicators are signs of green shoots emerging, China’s persistent and rising debt load poses a serious threat to the economy.
237% and counting
Debt has been financing the extraordinary growth rates that China has sustained so far. China’s credit growth has surged to 237% of GDP today from 164% in 2008, far above emerging market counterparts and is still growing. While there are countries with higher debt levels, the reason for concern in China’s case is the recent pace of credit growth, coupled with the declining quality. The dilemma facing the Chinese government is whether the new consumption led economy can support growth if credit is cut off from the private sector. In 2016, China faces a record 3.7tn yuan (US$567bn) of local bond maturities through year-end and this comes amidst deteriorating investor sentiment following news of seven companies reneging on their obligations so far this year. Non-performing loans (NPLs) have reached a record 1.3tn Yuan and account for 1.7% of total loans, and anecdotal evidence suggests this number is higher than disclosed. While most countries have seen their NPL loan growth decline recently, China remains an exception as highlighted in the chart below. (Click to enlarge)
Back in 1999, specially created asset management companies relieved the big four state banks by buying these NPLs with government backed 10-year bonds. China’s rapid pace of expansion in the 10 years since 1999 helped shrink the debt levels from 20% to nearly 5% of GDP. However, since the maturity of those bonds came in the midst of the financial crisis in 2009, it seemed prudent at the time to roll over their maturities (to 2019) rather than recognize the losses. The Chinese authorities have recently announced their intention to deal with these non-performing loans in the banking sector with an Equity-for-Debt Swap (EDS) and securitisations of NPLs. The EDS will enable banks to swap bad loans on their books for equity stakes in the stressed corporates. While this will certainly allow banks to reduce the need to provision for loan losses aiding better use of their capital, it is hard to assess the time it will take for the stressed corporates to recover. We believe these are not comprehensive solutions by themselves and simply delay the inevitable to a later date.
Margin trading magnified market volatility
Stratospheric margin lending up 3057% since September 2012 – fuelled the MSCI China A shares index to attain a record high 5458.9pts in June 2015.
The balance of margin financing outstanding as a percentage of market capitalisation in June 2015 reached a record 4.09%.
These high levels of leverage explain the fast run up to the peak and its subsequent decline thereafter. Rising stock prices made it easy to repay margin interest rates however when these stocks reversed their trend, investor losses exceeded their margin payments forcing them to liquidate their equity holdings and exacerbate the downward slide. In an effort to contain these risks, the securities regulator capped the size of margin trading and short selling for the first time at 4x a brokerage’s net capital. Since the start of 2016 the outstanding balance of margin transactions has declined by 35% and has had a direct repercussion on the market.
Market meddling leads to lacklustre trading
Chinese stock markets got off to a turbulent start in 2016 that forced it to suspend trading activity twice in a matter of a week after 7% declines tripped a new circuit breaker mechanism. While the initial intention was to avoid panic selling, it appeared counterproductive forcing the mechanism to be withdrawn just days after being introduced. The lack of transparency from the stock market regulator caused more harm than good resulting in a loss of investor confidence.
Equity valuations not so cheap
The MSCI China A Shares Index currently trades at 18x earnings – seemingly attractive on the surface. The reality is that financial stocks, which account for 35% of the index, tend to deflate the index valuations due to their low valuations, at 4x earnings. By stripping out the financial sector and applying the valuation gap (difference in P/E’s of MSCI China A shares index excluding financials and the MSCI China Financial Index) we obtain a more realistic valuation of 28x earnings for the MSCI China A shares index.
Conclusion
While there is rising evidence that a majority of macroeconomic indicators are benefiting from China’s accommodative monetary policy, we believe it will eventually have to contend with its rising debt load. Credit expansion has expanded at an alarming rate, this coupled with the declining quality of debt makes it imperative for China to transition from an investment to a consumption driven economy. The lack of clarity and transparency by Chinese stock market regulators has subdued investor sentiment. From a timing perspective, Chinese stock markets are not as cheap as they appear since their valuations are flattered by financial stocks. For the time being we remain cautious on Chinese equities until the emerging green shoots become more established.
Important Information
General
This communication has been issued and approved for the purpose of section 21 of the Financial Services and Markets Act 2000 by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”).
The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.
För att hjälpa dig att hitta spännande ETFer har Nordnet tagit fram en inspirationssida. Där kan du se vilka ETFer som är mest ägda och har bäst utveckling inom olika regioner och branscher. Här är de 10 mest populära ETFerna oavsett bransch och region. De mest populära ETFerna hos Nordnet just nu.
Det finns i dagsläget fler än 1 600 ETFer på Nordnets plattform och du kan hitta någon i så gott som alla sektorer och regioner. Det svåra är snarare hur du ska hitta rätt, i det omfattande utbudet.
Med NordnetsETF-sorterare får du hjälp att söka ut ETFer som matchar dina önskemål. Du klickar helt enkelt i vad du söker och får en lista anpassad till detta.
Innan du köper ETFer finns det några saker det är bra att ha koll på, nämligen:
iShares FTSE MIB UCITSETF (Acc) (SXRY ETF) med ISIN IE00B53L4X51, strävar efter att spåra FTSE MIB-index. FTSE MIB-index spårar de 40 största italienska företagen.
Den börshandlade fondens TER (total cost ratio) uppgår till 0,33 % p.a. ETFen replikerar det underliggande indexets prestanda genom fullständig replikering (köper alla indexbeståndsdelar). Utdelningarna i ETFen ackumuleras och återinvesteras.
iShares FTSE MIB UCITSETF (Acc) har tillgångar på 211 miljoner GBP under förvaltning. Denna ETF lanserades den 26 januari 2010 och har sin hemvist i Irland.
Varför SXRY?
Exponering mot brett diversifierade italienska företag
Det betyder att det går att handla andelar i denna ETF genom de flesta svenska banker och Internetmäklare, till exempel DEGIRO, Nordnet, Aktieinvest och Avanza.
Recent market movements reinforce the investment case for crypto index investing and we believe that now is the time to build a long crypto exposure via the Nasdaq Crypto Index (NCI) (or to boarden the exposure vs. a single asset Bitcoin ETF position).
Here are some commentaries from our Research:
• NCI surges +18% last week (Nov 3 to 10) while Bitcoin was up +15%: driven by market optimism following Trump’s election and a 25 bps rate cut by the Federal Reserve
• Bitcoin breaks new highs: Closed the week above $80k for the first time, leading a market rally
• Outperformance across NCI constituents:
o Smart contract platforms led gains:
Cardano: +72.6%
Avalanche: +31.4%
Ethereum: +27.2%
Solana: +25.4%
o All constituents (except LTC) outperformed Bitcoin’s gains, see below for last week:
• BTC Dominance tested 60% and retraced: Historically, this has either signaled the end of Bitcoin outperformance or the start of a powerful Altseason
• Strong performance outlook: Momentum in NCI’s broad diversification positions it well for potential long-term gains as macro and regulatory conditions improve
Nasdaq Crypto Index – Constituents performance Nov 3 – Nov 10:
Evolution of Bitcoin dominance:
Why consider Nasdaq Crypto Index (NCI) now?
• Diversification beyond Bitcoin: Capture both Bitcoin’s strength and the upside potential of emerging crypto assets in one allocation.
• Positioning for Altseason: NCI provides targeted exposure to key market segments poised to benefit from broader market growth.