Stock Market: The China Rally Explained

(Drivebycuriosity) - China`s stock market is on a tear. The Shanghai Composite, a gauge for China´s stock market, climbed 61% in the recent 12 months, the hugest rally since 2006/07.

The China rally looks contradictory in the face of reports that China`s economy is cooling. But I think, the rally has been overdue.  I have been writing for years that the sentiment for China stock is way to negative and China´s stock are ridiculously undervalued (here  here).

Notorious China bears, including Jim Chanos, a hedge fund manager and short seller, and New York Times correspondent Paul Krugman, have been banging the "China crash drum" for years (driveby). According to the China skeptics, the country is suffering from huge structural problems like too high debts and too huge investments into real estate which would cause a "hard landing" of the Chinese economy. I reckon that the China pessimists focused too much on the problems and overlooked the fundamental strength of the economy and the progress the country is still making. But they were followed by the media and created a very negative sentiment for China investments. Since 2011 the Shanghai Composite has been trapped close to the mark 2,000 thanks to the continuous negative sentiment (China pessimism bubble).





                                                Soft Landing Accomplished


But last autumn the China pessimism bubble burst - finally.

1. The China crash callers have been proven wrong. Last year China`s economy grew 7.4% (just 0.3 point less than the year before) - much better than the crash the China pessimists have been announcing for years and a confirmation for those who expected that the country will accomplish the soft landing of its economy (china).

2. China`s stock market is benefitting from continuing reforms that started in 2013 (blueprint). Last year Beijing announced the liberation of stock trading between Hong Kong and mainland China, softened the one-child policy, encouraged migration to bigger cities (with a higher productivity, announced more investments into airports, railways and other infrastructure and more.

3. Since last autumn China´s economy gets a lot of tailwinds from the drop of oil and other commodity prices (around 50%). Inflation rates are falling, consumers have more  money to spend and industries (especially the transport sector) have less costs.

4. China`s central bank is responding to  slowing economy and falling inflation rates (thanks to cheaper commodities) and is lowering interest rates & restrictments for the banks.



                                            Secular Catching-Up Process

I am basically optimistic for China because of the secular catching-up process which is fueled by the still 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 strong retail sales (growth rates around 11%) 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 soft landing and stock market rally will continue in the coming months because of the ongoing reforms, cheaper commodities and a more accomodative monetary policy.