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Beijing - Optimism over China’s economy has driven gains in the world’s second-largest equity market this year. But that budding recovery could also be investors’ undoing.
Some money managers are turning cautious on Chinese shares on concern the economic rebound will gather enough momentum that the central bank has to tighten monetary policy further.
While the People’s Bank of China has emphasized its neutral course in 2017 and steered clear of boosting benchmark interest rates so far, mainland markets have started to price in a “major hawkish shift” from the PBOC, according to Goldman Sachs.
“Where stocks will head will really depend on how fast the government tightens monetary policy and how fast company earnings will recover - it’s like a competition between these two things,” said Dai Ming, who manages a fund of structured products for investing in Chinese equities at Hengsheng Asset Management in Shanghai. “There could be a further correction in the stock market.”
China’s CSI 300 Index has climbed more than 3.5% in 2017, winding back some of last year’s 11% slump as evidence Asia’s largest economy is on a stronger footing started to mount. Analysts surveyed by Bloomberg at the end of 2016 were bullish, predicting a strong rally as signs of growth become more embedded.
The CSI 300 edged up 0.1% as of 09:30 on Friday, following declines Thursday after an uptick in producer-price growth boosted the outlook for Chinese, and global, reflation. The economy accelerated for the first time in two years last quarter, manufacturing is gathering pace and China saw its steepest import growth in five years in February.
Main risk
While the market fallout from the PBOC’s focus on curbing leverage has so far centered on bonds, the potential for tightening is a “main risk” for mainland shares, said Shi Bo, chief investment officer at China Southern Asset Management, the country’s fifth-largest mutual fund manager, overseeing 390 billion yuan.
“Higher lending rates drive up the cost of borrowing for companies, providing a potential hit to earnings,” said Chen Li, an A-shares strategist at Credit Suisse in Hong Kong.
Monetary tightening will “definitely” impact Chinese shares, “though the impact will likely be less severe on stocks than on bonds.” Qiu Dongrong, manager of the 2.64 billion-yuan HSBC Jintrust Large Cap Equity Securities Investment Fund, said he’s turned less aggressive on Chinese stock allocations.
“Whether China will maintain a tight stance over monetary policy and for how long will be a key focus for 2017,” he said. “Corporate earnings may be put to the test.”
“Equity markets have been roaring along because economic data have been very strong globally and we’ve had some very loose monetary policy,” said Marc Franklin, a fund manager in Hong Kong for the Asian unit of Conning, which manages about $109bn globally. “Policy stimulus needs to normalise.”
Though these investors have their concerns, the wider consensus is bullish. Citigroup reiterated its positive A-shares stance March 5, while UBS and even Chen at Credit Suisse see the market higher by year-end. Morgan Stanley predicts the Shanghai Composite Index’s 2017 gains will be more than double that for Hong Kong-traded Chinese stocks.
Economists, too, see a moderation in Chinese producer-price inflation toward the end of the year as commodity prices come off and curbs on the property market bite.
There’s also the China intervention factor. Regulators are said to have supported equities this week amid the National People’s Congress and will want to avoid instability in the markets ahead of the twice-a-decade Communist Party conclave later this year, when almost half of China’s most senior leaders may be replaced.
“The government wants a stable market heading toward the key 19th Party Congress,” said Dai at Hengsheng Asset Management. “If it falls too much, someone will step in and support it.”
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