Despite continuing high levels of economic growth over the next few years, the Chinese A-share market will suffer in the next year or so, warns Li Jianyong, CEO at mainland China broker GF Securities and director at Guangzhou-based fund house E Fund.
Speaking at AsianInvestor’s 5th annual Taiwan Institutional Investor Forum in Taipei this week, Li says China’s still-loose macroeconomic policy combined with controls designed to combat inflation and a real-estate bubble will hurt equities in 2011 and into 2012.
“It is not a bullish market,” he says. However, these government measures are helping to rebalance China’s economic growth. That, in turn, will see Chinese companies rely ever more on capital markets to sustain their growth. This should drive capital markets to new highs, particularly once the government succeeds in pricking the real-estate bubble of tier-1 cities.
Li argues that the long-term ‘megatrend’ of high Chinese growth, unleashed under Deng Xiaopeng in the late 1970s, remains on track and will last another two decades or so.
But what could change is the speed of that growth. Premier Wen Jiabao continues to highlight shortcomings in the Chinese growth story, notably its overuse of natural resources, the resultant income disparity across society, a lack of innovation and structural imbalances.
These imbalances include diverging fortunes between the coast and the interior, and the overreliance upon exports and an underutilised consumer sector. The recently announced 12th five-year plan is meant to correct these, and the Communist Party now calls for GDP annualised growth to slow to 7%, with inflation capped at 4%.
Two factors put this strategy at risk: inflation, and the real-estate bubble.
Li explains that just looking at China’s CPI figures are not helpful, because the real problem is in the price of food. This is a serious problem for a nation of 1.5 billion people, most of whom are still poor.
Food price inflation is getting worse for a variety of reasons. First is American monetary easing; expectations of a weakening US dollar have pushed up the price of oil and other dollar-denominated commodities, in yuan terms.
Secondly, nominally higher oil prices (anything over $70/barrel, says Li), prompts more reliance upon biofuels. Biofuel production is increasing, which takes away arable land and resources from producing food.
More recently, the Fukushima disaster and turmoil in the Middle East are also pushing up energy prices; in the long run this too will encourage the development of alternative energy, which means biofuels, which means more expensive food.
This has created a challenge for the People’s Bank of China, which since late 2008 has eased monetary supply to support the economy, but at the risk of overdoing it and triggering inflation.
In response it has reacted with technical measures and some interest-rate hikes, but Li says investors should not confuse this with an end to a loose monetary policy. Monetary policy remains relaxed, and the PBoC is using such measures to tame the excesses in prices.
Li believes the government will, therefore, fail to bring GDP growth down to 7%, and fail to keep inflation below 4%, in the first year or two of its five-year plan.
Meanwhile the real-estate bubble is another source of concern in China. “The Premier has ordered prices must come down but the market isn’t listening,” Li says. The government is concerned that housing prices are too high for most people, and it hears comments from the international financial community warning that China’s tier-1 cities face a residential bubble far bigger than Dubai’s.
However, Li notes the government is not trying to suppress real-estate prices. It is simply trying to moderate their rise. Nor does he see the bubble as a huge threat. It exists only in tier-1 cities; down payments for mortgages are high, 30% or more; and borrowing comes with stringent restrictions. Moreover there is no US-style securitisation market for residential mortgages in China, and therefore no way to leverage a loss.
Ultimately, Li notes that property questions in China are not about economics, but about political and social choices. The regime needs this sector to remain stable, so it will implement whatever controls it has to moderate and perhaps prick any bubbles.
He argues that, in the self-contained world of Chinese domestic investment, A-shares should rebound if real-estate prices correct. But government policies trying to prevent or manage a bursting bubble, along with controls on prices, are creating a difficult short-term environment for stocks.
The market is unlikely to really take off until the real-estate bubble has been checked, and as the latest five-year economic plan gradually puts GDP growth on a more sustainable footing.