09.07.2020 – Special Report. History repeats itself: the government in China is apparently making the same mistake as in 2015: five years ago, the regime was quite at the top and on the verge of bursting its bubble had asked its citizens to invest in stocks. Now we are hearing the same sounds – and China’s stocks are bullish. Indeed, Beijing is in a dilemma because of the yuan. We shed light on the background.
Everything has been there before
In 2015, the state media had praised the high stock prices – they were a “reform dividend” which would be paid out as a result of the new economic policy of President Xi Jinping. And Prime Minister Li Keqiang encouraged companies to increasingly take out loans backed by shares as collateral, recalls “The National Review”.
State press fires up the bull market
This time the state-run “China Securities Journal” praised the bull market, as the financial blog “ZeroHedge” noted. A front page commentary said that the post-pandemic bull market is more important to the economy than ever. And the “Shanghai Securities News” posted a stupid headline on WeChat according to the “National Review”: “Hahahahaha! The signs of a bull market are becoming more and more obvious. In fact, on Monday, the Shanghai Composite posted its strongest daily gain since 2015 with a plus of 6 percent.
And the CSI-300 is also showing an impressive run at the moment. The index has already gained around 15 percent this month alone, thus extending the recovery rally that has been underway since March. Admittedly, it is nothing unusual for prices in China to be extremely volatile. But investors should bear in mind the example of 2015, when around 1.3 trillion euros disappeared into thin air in just a few days.
Run on China stocks
The “National Review” warned that trading volumes on the stock exchange had climbed to the highest level since 2015 – and retail investors in particular had entered. This also reflects the limited opportunities for Chinese savers. One of the reasons for the current bull run was a new guideline issued by the China Banking and Insurance Regulatory Commission in January, which called for the diversion of savings into long-term funds and the capital market. Correspondingly, many commercial banks are likely to have advised households as the corona crisis eased.
Spread to Hong Kong
Furthermore, the spread between A-shares listed in the mainland and Hong Kong listed H-shares – the so-called A/H premium – has increased by a whopping 30 percent in the past month. The fact that the Chinese in the People’s Republic are willing to spend more money on the same share than their trader colleagues in the former British Crown Colony is a warning signal – not the economic fundamentals, but the loose monetary policy and the optimistic mood are tempting to buy.
Share purchase on margin booming
But currently the Chinese are obviously overdoing it – they are taking full risk: according to Bloomberg, the margin loans taken out with brokers have now reached 1.16 trillion yuan or 164 billion dollars – the highest level since 2015. Incidentally, the crash five years ago was also triggered by tighter regulation on debt to buy stocks. So look for signs in the news for restrictions in the margin lending of brokers – this could cause the bubble to burst again today.
In addition, analyst Masanari Takada of Japanese bank Nomura warned that while the masses may be right in assuming that fundamentals are recovering – corporate earnings rose by 6 percent in May. However, even a small break in the trend could reverse the leverage and trigger a sell-off.
Possible interest damper
Another problem for the stock market could be the recent strength of the yuan, which was recently quoted at 6.98 against the greenback and is of course also a consequence of the bull market. Unfortunately, however, it is curbing Chinese exports. As a result, sooner or later the PBOC will probably have to devalue the Yuan or raise interest rates – which would put a damper on the stock market. By the way, in 2015, the central bank had triggered such a sell-off when the Yuan fixation against the Dollar was lowered by 1.8 percent.
So you should also keep an eye on monetary policy: Because the recent hike in short-term interest rates suggests that the People’s Bank of China (PBOC) will not support the bull market forever. For example, the three-month shibor climbed to 2.13 percent in June from 1.45 percent in May.
Beijing wants to uncouple itself from the dollar
Which brings us to the yuan – and thus probably the real reason for the stock market boom. Recently, the state-run “South China Morning Post” published an article that brings into play an interesting connection between the currency and the Chinese stock exchange. Under the title “Time for China to decouple the yuan from US dollars, former diplomat urges”, Zhou Li, a former deputy director in the Communist Party, was given the floor. His warning: the dollar is a weapon on China’s neck. The country had to decouple itself and internationalise the yuan. The People’s Republic had to give up the illusion of friendship and prepare for an open conflict with the USA. To this end, international payments in yuan should be possible, and the renminbi should be increasingly used in the industrial supply chain.
Cash outflows from China funds
We think: Of course, a yuan uncoupled from the dollar would collapse as money flows out of the country. And this is the crux of the matter: As Goldman Sachs recently reported, there have been 11 consecutive weeks of net outflows from Chinese equity funds to the rest of the world. Against this backdrop, Beijing must provide rising prices. Brokers around the world should exchange dollars for yuan and buy Chinese shares.
Our conclusion from this mixed situation: The regime apparently wants a bull market to strengthen the yuan. But at the same time this weakens foreign trade. Speeches from the political arena should make investors prick up their ears. To be sure, they often trigger a stampede and prices continue to rush higher. But the big end could still come, because the professionals are selling their expensive stocks to amateurs. And because politicians suddenly change their minds, for example because priorities change or new people in the inner circle of power take over. In short: political stock markets have short legs.
The Bernstein-Bank keeps an eye on the matter for you and wishes you successful trades and investments!
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