Greed Makes a Comeback in China as Hot New Trade Sparks 5% Rally

Tuesday 11th August 2015

August 10, 2015

Greed is once again trumping fear in the Chinese stock market.

The Shanghai Composite Index surged 4.9 percent on Monday, posting the broadest rally in at least 17 years on speculation that China will start a new round of consolidation among state-owned companies. Investors snapped up shares even as export and producer-price data signaled economic growth is getting weaker.

For the first time since Chinese authorities stepped in to prop up the market last month, equity prices surged without obvious signs of state intervention. Instead, traders piled into shares that would benefit from reform of government-run companies, an echo of the speculative buying that characterized the Chinese market before it began a nearly $4 trillion tumble in June. China Shipbuilding Industry Co. and Aluminum Corp. of China Ltd. were among state-owned firms that rose by the 10 percent daily limit.

“A few daily limit-ups could get the animal spirits roaring again among A-share investors,” said Wendy Liu, the head of China equity research at Nomura Holdings Inc. in Hong Kong.

Turnover on Chinese bourses climbed above 1 trillion yuan ($161 billion) for the first time in seven days as the Shanghai Composite jumped as much as 5.3 percent. Just two stocks in the benchmark index retreated while 980 gained, the broadest rally since Bloomberg began compiling the data in 1997. The CSI Central SOEs Index surged 5.6 percent.

Merger Bets

China is considering combining China Shipping Group and Cosco Group, its two major shipping companies, people familiar with the matter said last week. The nation’s cabinet has approved a proposal to overhaul SOEs, the biggest plan of its kind in more than a decade, the South China Morning Post reported.

The Communist Party’s ruling Politburo said at its midyear economic work conference that reform of SOEs is one of three key priorities for the second half, China International Capital Corp. analysts led by Hanfeng Wang wrote in a research note Monday.

“There are lots of listed SOEs on this market, which leaves a lot of room for imagination,” said Li Jingyuan, general manager of the securities investment department at Shanghai Zhaoyi Asset Management. “Given the fact that they are all big weightings in the index, their share-price gains can lift the broader market and boost sentiment.”

Trading Surge

Monday’s rally followed signs of deteriorating investor sentiment in recent weeks. The number of new individual investors opening stock accounts dropped to the lowest level since the government began publishing data three months ago, while margin traders reduced bets on shares using borrowed money by more than 40 percent since mid-June. Turnover on Chinese bourses fell to a five-month low on Aug. 6.

To be sure, today’s trading didn’t reach the extreme levels seen during the headiest days of the Shanghai Composite’s rally a few months ago. Turnover was about half the record 2.4 trillion yuan on May 28, and the benchmark index is still down 24 percent from its June 12 peak.

Gains in shares of SOEs may be warranted because China is poised to make the companies more responsive to market forces, according to Robert Buckley, a managing partner for Asia at Aviate Global LLP in Hong Kong. He recommends shares of China Unicom (Hong Kong) Ltd. as a way to benefit from reform in China’s telecommunications industry.

Grand Topic

“Reform of the SOEs has to happen,” said Andrew Sullivan, head of sales trading at Haitong International Securities Group Ltd. in Hong Kong. “Most are very inefficient, waste resources and are uncompetitive on an international basis.”

For Tommy Xue, an analyst at Huatai Securities Co. in Shanghai, valuations for many state-owned companies are still too expensive to justify buying.

Aluminum Corp. of China has a price-to-book ratio of 3.5 and China Shipbuilding Industry trades at a multiple of 4.8, according to data compiled by Bloomberg. That compares with 2.3 for the Shanghai Composite.

“The good thing about the story of SOE reform is that it’s hard to prove wrong and it’s a grand topic,” Xue said. “But the story has been on and off many times. Besides, many cyclical SOE stocks have very high valuations now. So we are conservative.”

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