Strategy Report - From desperation for survival to desire for peak: what a fast move!

Date: 10 Jul 2020

  • The recent fast rally is mainly driven by liquidity; earnings need to catch up to justify valuation expansion
  • H shares more fundamental driven; likely to perform better in 4Q
  • Watch out risks after such a strong run

“The only true wisdom is in knowing you know nothing.” by Socrates

A share market: As of July 8, CSI 300 Index has gained 15% MTD (YTD: 17%). There are highly divided views on whether it's a solid bull market lasting for months. A comparison with some key factors in the 2015 bull cycle can be used for reference. Market turnover: A share market turnover exceeded RMB1tr for five consecutive trading days from July 2 to 8, averaging RMB1.38tr, while the average daily turnover as percentage of total market cap reaching 2.0%. This figure is lower than 3.2% peak level made on May 28, 2015 (RMB2.36tr turnover). Valuation: CSI 300 Index trades at 15.1x forward P/E, 22% below the peak of 19.4x forward P/E reached during the 2015 bull cycle. Investor sentiment: the market witnessed high enthusiasm from new participants. However, the memory of bubble burst in the 2015 cycle, such as ‘limit down’, suspended trading of >1,000 stocks on a single day and deployment of ‘national team’ underpinning the market, may not fade away. Market veterans tend to be more cautious. Fundamental: resumption of production and consumption in China is carrying on. The recent macro data suggests policy efforts are bearing fruits. However, we should acknowledge challenges and uncertainties as well: 1). external demand remains weak and recovery of global value chain could take longer. 2). consumption recovery could be impacted by worry on a potential 2nd wave of COVID-19 outbreak. 3). intensified disputes between US and China. Regulation: One of the most important driving forces of 2015 bull market was underground margin financing (场外配资). Currently, the CSRC pays close attention to illegal margin financing. According to news reports, the CSRC repeatedly asked brokers to refrain from providing convenience to unregulated margin financing, issued a list of >200 illegal financing platforms for investigation and punishment. Clearly, the government’s intention is injecting sufficient liquidity to real economy instead of boosting asset bubbles. This suggests that margin financing magnitude could be lower than the 2015 cycle.

HK market: As of July 8, Hang Seng/MSCI China Index advanced by 7%/13% respectively MTD (YTD: -7%/15%). Market turnover surged to an average of HKD229bn over the past three trading days. The rally is mainly due to the spill-over effect of A share market. In the last bull cycle between October 2014 and June 2015, CSI 300 Index gained 126%. However, the rally of HK market happened as late as in March 2015 and quickly peaked out in late-April 2015, with accumulated gain of 20% only. HK stock market is dominated by institutional investors who tend to be more rational and fundamental-driven. Having said that, we do see rising impacts from A shares investors on HK market through stock connects.

Our view: The fast rally is mainly liquidity instead of fundamental driven. It could last longer if earnings could catch up soon; otherwise, there is likelihood of pullback. Key catalysts/risks: 1). forthcoming results season; 2). macro data; 3). COVID-19 infection development.

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