China: Why Morgan Stanley Is Wrong

(Drivebycuriosity) - This morning the Shanghai Composite, the gauge for China`s stock market, plunged 7.4% and lost around 18% for the week.

After a rally of about 150% over the recent 12 months the market has become increasingly nervous and volatile. Todays plunge got aggravated by Morgan Stanley and other negative analyst comments (bloomberg). Morgan Stanley claimed that China`s stock market had already passed its peak. The bank set a new 12-month Target Price range for Shanghai Composite of 3,250-4,600, that´s  minus 30% to minus 2% below the current level of the index. They alledged that an increased equity supply (more IPOs), continued weak earnings growth in the context of economic deceleration,  high valuations, and very high margin debt to free float market capitalization will send the stocks north.

I think they are wrong - and this correction will be short lived. The Shanghai Composite is a bet that China´s exceptional growth will continue. And the chances are good. The recent data from China´s economic front are encouraging: It seems that manufacuring has stopped the slow down this month (cnbc) and retail & industrial production stabilized in May (cnbc). There is a large chance that China´s growth rate in the second quarter was close to the number from the first quarter (plus 7%).

China´s stock market is still benefitting from some tailwinds:

- Beijing is successively 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) and more.
- Chinese centralbank has been reducing interest rates and rasing bank liquidity step by step.
- Exports get fostered by the growing US economy and the recoveries of Europe & Japan
- Lower oil and other commodity prices  reduce inflation rates;  consumers have more money to spend and industries (especially the transport sector) have less costs.




                                                          Bright Future


I believe that the future is bright for China - and justifies the stock market rally of the past months. The country 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.

China´s growth also gets 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.

Therefore the expected increasing equity supply will be digested, earning growth will get better and the high margin debt will be coverered by rising stock prices & climbing wealth. China´s stock market has still room to grow and the bull market will continue. Enjoy.