China's equity bull run can continue despite decade-high valuations, risks of a second Covid-19 wave and political ructions with Western economies.
In early July, the Shanghai Composite hit a two-and-a-half-year high of 3,383, while the CSI 300 index - which replicates the performance of the largest 300 stocks traded on the Shanghai and Shenzhen exchanges - reached a record high 4,753 - a full 34% above its March low.
The surge stemmed from a front-page editorial in the state-owned China Securities Journal, which said it expected a "healthy bull market", urging investors to look forward to the "wealth effect of the capital markets".
A recent note from Capital Economics pointed out some worrying comparisons with 2014/15's Chinese equity bubble, when the CSI 300 rose 150% in the space of 12 months before almost halving in the intervening seven months.
Both episodes were characterised by "new traders flooding into the market and trading volumes surging as many of them borrowed money to invest" alongside a rise in the value of margin accounts and a widening gap between domestic ‘A' shares and offshore ‘H' shares, noted senior markets economist Oliver Jones.
There is no denying, said Wise Funds' portfolio manager Vincent Ropers, that "valuations are less attractive now in absolute terms than they were earlier in the year", a general comment most fund managers investing in the area agree with.
Valuations 'full but not overly stretched'
However, while an earnings multiple for the MSCI China index of around 18 times is "as high as it has been for a decade", this metric may be "misleading, as part of the rise in multiple is due to a lower earnings number for 2020", according to head of Asia income at Liontrust Asset Management Mark Williams.
Looking from a price-to-book point of view, which tend to be less subjective, being based on historic asset values rather than earnings forecasts, "valuations look full but not overly stretched" at around 1.7 times.
Indeed, the recent run "needs to be considered in the context of several years of underperformance for domestically listed Chinese equities", suggested Fahad Hassan, CIO at Albemarle Street Partners, who claimed valuations are, on fact, "in-line or cheaper than many global indices".
There are plenty of reasons to suggest valuations can continue to climb. The CSJ article "constitutes a significant bullish signal", according to global equity analyst at Sanlam Investments Louis Jamieson, as "China is generally a policy-driven stockmarket".
That said, while authorities may be happy to allow the bull run to continue, Kunjal Gala, GEM co-portfolio manager, international at Federated Hermes, said regulators were also mindful of any bubble building and were "taking steps to rein in speculation in equities, including effectively withdrawing liquidity from the financial system".
There are also more fundamentals-based reasons there is more juice in Chinese stocks, with Wenli Zheng, portfolio manager for T. Rowe Price Hong Kong Limited, urging investors to "focus on the medium and long‑term outlook and solid fundamentals of many Chinese companies".
"China is expected to escape negative growth in 2020, with an annual GDP increase in the 2% to 4% range," Zheng said. "In turn, this should enable Chinese companies to be among the first to embark on a new earnings growth cycle in 2021."
Federated Hermes' Gala noted China's growth had bounced back swiftly, registering a 3.2% GDP uptick in Q2 following Q1's 6.8% contraction. "This is no easy feat given the extent of damage in Q1 and the backdrop of global recession."
Liontrust's Williams noted central banks across Asia have been busy slashing interest rates, which is positive for risk assets. "As rates go down, asset prices should rise, and maybe this, combined with the massive stimulus packages, justifies the recent recovery in markets," he explained.