Why China Remains Our Favorite Market For Investment
The current Chinese market correction will be off and on for a few more weeks as the Chinese government tries to convince the public that they want the market to rise, but in a systematic and non-speculative manner. During this period we expect higher Chinese equity prices. Last week, in an effort to rein in stock market speculation, the government announced that they will allow public offerings by more companies in coming months in order to create more supply of stock for the public to buy. Demand is thought to be too high, so a program of increasing supply has been begun.
- Buyers can only get a full allocation if they’re holding enough cash to pay for it; and
- New issues are grossly underpriced, and can double or triple immediately after the offering — so it makes sense for potential buyers to hold the cash needed to get the largest possible allocation if it is given to them.
Besides newly public companies, companies that are already public are offering huge amounts of new stock. The Chinese government itself, as well as companies that have large foreign banks holding their shares, are pressuring these large foreign institutions to liquidate their shares. These share liquidations add to supply.
Also last week, some Chinese brokers raised margin requirements when an article appeared in the government-connected Caixin magazine in Beijing stating that the government would eventually disallow margin loans to clients exceeding four times a broker’s net capital.
The government rule has not yet been announced, but the brokers cut margin lending in expectation of that rule being implemented. We anticipate that there will be continued stock offerings at higher Yuan values, and that margin rules will be tightened more than once as the regulators try to incentivize higher stock prices but only at a steady and moderate growth rate.
Why is the Chinese government incentivizing a sustained and moderate appreciation of stocks?
- To encourage economic growth. The economy can grow faster if financial activity (purchases of stocks and bonds and increased company financing) grows steadily.
- Because of the wealth effect. Consumers who make money in the stock spend part of that money on goods and services, stimulating China’s consumer spending as a percentage of GDP and strengthening GDP growth. The combined effect of these two sources of growth is believed by some to contribute 0.6 to 1 percent of GDP growth. China wants faster growth for the economy, hoping for 7 percent in 2015. The consumer is the expected avenue for growth, so activity that can increase consumer spending is encouraged — within limits.
Repeated visits to China and research on the country have led us to be very bullish on the Chinese consumer. We are actually much more bullish than most others on the rise and influence of Chinese consumer, and we will write a larger section explaining why next week.
Even if the government does not grow GDP by as much as hoped, this process further acquaints the Chinese consumer with stocks and bonds, and begins to make a good impression on foreign nations who are considering China as a potential member of the IMF Special Drawing Rights (SDR) basket.
Currently, the SDR basket contains the currencies of several major nations: the U.S. Dollar, the Euro, the UK Pound, and the Japanese Yen. China has expressed great interest in being included in that basket. The basket’s composition and whether to include the Yuan will be reviewed in November 2015, and repeated every 5 years. SDRs are a claim on the IMF member countries’ non-gold foreign exchange reserves, which are usually held in the SDR currencies.
Last weekend, right after the markets had gotten a scare from too many IPOs and tightening margin requirements, the Chinese government lowered interest rates for the third time in the past six months by 0.25 percent, to encourage more lending and to free up consumer spending. Inflation is low in China, so they also lowered the one year deposit rate by 0.25 percent. This decrease slightly incentivizes more people to buy stocks instead of holding bank accounts.