12 JULY 2013
Dr Chan Yan Chong’s Column
By Dr Chan Yan Chong
On 9 July, the Dow Jones Industrial Average surged past 15,300 points – a mere 1.5 percent away from the historical high. The Hong Kong and Singapore bourses, too, rebounded with China the only market that continued to underperform. There is still a lack of confidence in the Chinese stock market despite a rebound in early June, which is why the Hong Kong and Singapore bourses have also been weaker relative to the US market.
The US Federal Reserve has been warning of an exit from QE III in the last two meetings resulting in a lot of volatility in the markets. I have warned that such a move by the Fed is to pre-empt investors for the moment of truth. The Fed will first cut the amount of bond buyback before deciding whether or not to raise interest rates. The rebound has taken place as fast as the correction had taken place but we will continue to be affected by the exit strategy. We need corporate profits to boost the stock market, hence, we can say that the current rebound has more or less to do with better-than-expected profits announced by companies.
It is obvious that the sentiment in China has been hit by the new government’s stance to tighten monetary policy. The move to drain off liquidity has helped to drive away hot money and bankrupted the “shadow banks” – moves that will ultimately lead to the internationalisation of the yuan. When the A, B, H and N shares merge in the future, it will invariably lead to international speculators hitting Chinese financial markets.
The cash crunch in China has led to many problems but such a move is for the long-term good and paves the way for interest rates in China to be more market-oriented and to be more driven by market forces as opposed to depending on connections to get low preferential rates. When such connected people enjoy preferential rates, they can act as “shadow bankers” and farm out loans at higher rates to earn the difference. We do not know for how much longer will the cash crunch last, hence, the Chinese stock market will fluctuate according to the situation.
When the correction took place in early June, investors had expected the situation to improve in late June but on 2 and 3 July, the Hang Seng index plunged, hence, making investors realise that the worst was not over. The rebound in the Hong Kong market started only on 4 July but the rebound was weak and lacking in volume. I believe that many retail investors are still on the sidelines due to the possibility of even more volatility going forward.
Quite a number of initial public offerings (IPOs) have been postponed due to the weak sentiment but Freetech (HK: 6888) went against the trend by going higher because of news that the Chinese government investment corporation will be taking a stake in the company. The Chinese government will not invest in penny stocks, hence, I believe there is great potential in this stock. It has the ability to repair and build roads using the most environmentally-friendly ways. On 9 July, two weeks after it made its debut, the share price rose 32 percent above its IPO price.
Hong Kong does not have a central bank and the currency is pegged to the US dollar, hence, Hong Kong follows the policy of the US Federal Reserve very closely. Once US tightens, Hong Kong will do likewise and, thus, China’s cash crunch has affected Hong Kong in a very small way. The returns on the yuan is now much higher than the HK dollar – near zero – hence, investors are still clamouring for Hong Kong blue chips that pay higher dividends. The utilities and REITs paid lower yields because their prices were high before the correction. At current prices, REITs are looking attractive again.
I am of the opinion that the farmers working in the cities have the highest savings rate in the world because these people have no benefits and depend only on their savings for future livelihood. The urbanisation drive by the new government is not aimed at blindly pushing the farmers to seek work in the cities because the infrastructure and housing developments are aimed at hosting these rural people once they find jobs in cities. Once these farmers are able to enjoy a higher standard of living, they will start to spend and boost domestic consumption.
China has a high savings rate and plenty of funds parked by the sidelines. There is a mismatch between the stock market value and the performance of the economy, hence, the government does not encourage buying into shares owing to plenty of low-quality stocks listed on the mainland exchanges. Plenty of stocks listed from 2007 to 2012 tanked after listing their shares. The corporate profits have suffered ever since and investors have given up. This lack of confidence is something that the Chinese government needs to solve.
The authorities banned IPOs because they wanted to boost the demand for existing stocks already listed on the exchanges but to no avail. The only way to boost demand is to list more quality stocks at lower prices so as to give investors more upside to earn profits.
The new leadership is now making efforts to clear some of the backlog left behind by the previous leaders especially in the areas of inflation, false trade invoices and shadow banking. To tighten monetary policy is not the way to solve things because the root of the problem lies elsewhere. Investors are speculating on the possible next move made by the leaders so as to capitalise on it.
When the 1998 Asian financial crisis struck, I suggested a few ways to solve the problem of which one was to stop the internationalisation of foreign exchange trading as it will invite attacks from speculators. When Russia and Malaysia did that, it solved the problem and caused some hedge funds, including Long Term Capital Management, to fold.
There are three issues that need to be solved: Firstly, the savings rate is too high and money has nowhere to park; secondly, the interest rate is determined by the government and not by market forces; and thirdly, the yuan and stocks are too regulated for China’s own good.
Of the issue on savings rate, the Chinese are saving because there is no social safety net unlike in the West whereby people can spend and wait for the government to subsidise their old age needs. The issue of interest rate has caused the rise of shadow banks and asset bubbles, hence, these need to be solved. I believe President Xi Jinping will try his best to address these issues.
Publish date: 12/07/13