Wednesday, June 17, 2015

Stock Market: The Logic Behind China`s Rally

(Drivebycuriosity) - China`s stock market is on a tear. The Shanghai Composite Index, a gauge for the stock market in China, jumped about 150% in the recent 12 months! Stocks with primary listings in China are now valued at $10.05 trillions, an increase of $6.7 trillions in the past 12 month, reports Bloomberg (bloomberg). Now China overtrumps Japan ($ 5 trillion), but is still far behind the US (25 trillions).

Many believe that the huge jump is overdone and that China´s stocks are  in bubble. But I disagree. I think that China`s stock valuation, which is still less than half of the US, is appropriate. China´s stock market rally reflects the swift growing global importance of the country.  The stock market tries to evaluate the future, stock prices are the sum of the future company profits, discounted with an interest rate. China`s economy is still growing very fast, albeit moderately slowing, the last reported growth number was a plus of 7%. In some years China`s eonomy will reach the US level. With a population of around 1,2 billion - around 4-times the US number -  that will need just a quarter of the US per capita income.

The huge potential alone doesn`t explain the explosvie rally of the recent months of course.  I think we are seeing now a massive (positive) correction because  China´s stock market has been extremely undervalued in the recent years. Since 2011 many - maybe the majority of the pundits - have been continuosly predicting that China´s economy will crash soon (hard landing) which spoiled the sentiment for the Shanghai stock market (driveby). Since 2011 China´s stocks were priced for an armageddon.

                                                        Room To Grow

Last autumn the pessimism bubble finally popped, as every bubble has to someday. I think the sudden change has at least 5 reasons:

1. The alleged crash didn`t happen, China is still one of the fastest growing economies of the world.
2. Beijing is successive executing a fundamental reform program, iniated in 2013, including huge investments into airports, railways and other infrastructure, encouraging migration from the rural areas to bigger cities (with a higher productivity), softening the one-child policy, liberating stock trading between Hong Kong and mainland China and much more (driveby).
3. In the recent months Chinese centralbank has been reducing interest rates and rasing bank liquidity step by step.
4. China´s economy gets some tailwinds from lower oil and other commodity prices which reduces inflation rates; therefore consumers have more money to spend and industries (especially the transport sector) have less costs. 
5. The growing US economy is fostering China`s exports.

I believe that the Shanghai Composite Index will contuing his rise, because the country will manage the intended soft landing, meaning continuing high economic growth rates (not below 6%). China is still in the begin of a secular catching-up process which is fueled by extreme income & wealth differences to the US and other Western nation values. The huge country is rapidly transforming into a consumer economy like the U.S. and other modern countries. Many peasants are moving to the huge metropolitan centers which are spread all over the huge country to lift their standard of living. This creates a fast rising affluent middle class, giving consumer spending a boost as the still strong retail sales (the latest reported growth rates was 10%) demonstrate.

China´s growth should be boosted by the technological progress and advances of Internet, automatization of industrial production and 3D-printing. These developments raise efficiency and  productivity of China´s economy as success stories like Alibaba and Baidu demonstrate.

I believe that China´s stock market, which still costs less than half of the Wall Street listed stocks, is not in a bubble and has more room to grow. Enjoy!

PS For illustration I used a picture of the Chinese model Liu-Wen as a symbol for the modern China

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