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CIMB: Liquidity Key To A-shares Bubble
Aspire, Personal Finance | 15 July 2015
By: Lim Si Jie
Articles (169) Profile

The Shanghai Composite Index (SHCOMP) has faced its first and steepest loss in a week yet since 2008 after its recent rally over the past year. This was largely due to concerns about the Chinese government clamping down on margin-trading, and generally high valuations in the market.

Over the past five trading sessions, China’s benchmark Shanghai Composite index fell by 13 percent as investors grow increasingly wary of what many analysts describe as a bubble. Meanwhile, the skyrocketing A-share market has stirred a lot of debate.

Offshore investors are viewing the market as overvalued and at risk of a bust. Although CIMB agrees with the market consensus that A-shares are overheating, CIMB believes that the level is still below the 2007 bubble peak based on five different angles.

CIMB Heat Map

Based on CIMB’s heat map, there are emerging signs of possible risks simmering in the Chinese stock market with strong speculative sentiment. However, the market still has a reasonable distance to rise before it reaches the historical peak level before the bubble burst in 2007.

1. Traditional valuation metrics (P/E, P/B)

China’s A-share market (mainboard CSI300) is currently trading at a Price-Earnings (P/E) ratio of 19.2x, which is higher than the H-share (11.9x), US (17.7x) and Japan (15.9x) markets. However, CIMB notes that the A-share PE ratio for the next twelve months, excluding banks, is 38.1x; only slightly lower than the peak level of 43.1x in 2007.

Market cap to GDP is a long-term valuation indicator that was made popular in recent years by Warren Buffett, who called it “probably the best single measure of where valuations stand”.

The ratio for the China market is currently 97 percent for domestic markets. If H-shares are included, the ratio is at 114 percent. Even though the ratio is approaching the alert level of 120 percent, it is still lower than the 2007 peak level of 159 percent and the current levels of the US market (154) and Japan (128).

2. Fed model (earnings yield minus yield of long-term government bond)

Fed model is often used to measure the attractiveness of equities and help investors decide how to allocate funds between equities and bonds. The Fed model results of A-shares (CSI 300) are still in positive territory (0.8 percent) now, but close to zero as A-share multiples kept rising.

Watch Out For Indicators Of Peaking

While CIMB expects further upside for the A-share market from the liquidity perspective, analysts cautioned investors to keep a close watch on peaking indicators that might signal the end of the quick rally.

1. Divergence between market turnover and SHCOMP index

Market turnover and turnover ratio picked up in the first part of the 2006-07 bull market. The turnover ratio dropped after the correction on May 30, triggered by stamp duty hikes, did not return to the previous levels although the market rallied 50% after the correction.

Fortunately, the A-share turnover ratio is currently still broadly moving in tandem with the index.

2. Divergence of index and majority stocks

In the last stage of the 2006-07 bull market, the percentage of rising stocks kept falling despite index performance showing strong momentum. There were more stocks declining than rising counters in the final weeks despite the index moving in an upward trajectory. For now, such a signal has yet to be observed.

Liquidity Still Key To Direction Of Market

However, CIMB notes that the ongoing A-share’s strong momentum is triggered mostly by liquidity. The People’s Bank Of China (PBOC) is expected to keep a relatively easy monetary stance for the rest of the year to tackle imminent disinflation risk and growth risks. As such, A-share’s strong momentum will likely be sustained as the loose monetary policy boosts liquidity.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.


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