Between early 2006 and October 2007, the Shanghai Composite index of domestic stocks – largely closed to foreign investors – gained almost 400%. But now the talk is of an “outright crash”, as Tim Congdon of ING put it last week.
The Composite has lost about 40% since its October peak. An index tracking mainland shares in Hong Kong is down by a similar amount since then, while the Hang Seng has fallen by around 27% since last autumn. The flood of Chinese initial public offerings in Hong Kong and on the mainland has slowed to a trickle.
So what’s gone wrong? Global sentiment is one factor. China’s “newbie class of equity investors see many of the same headlines as the rest of the world’s punters do”, says Rob Cox on Breakingviews. Rising risk aversion and jitters over slowing global growth have taken their toll everywhere.
But a “home-grown liquidity squeeze”, as The Economist puts it, is also undermining confidence. “Inflation is everywhere,” says Citigroup’s Lan Xue. Producer prices were 6.6% higher than a year earlier in February and consumer prices hit a 12-year high of 8.7% as food and energy prices rose. Now, even prices in the famously competitive home appliance industry are rising. High inflation could fuel social unrest (the average household spends at least 33% of its budget on food) and has started to dent profits by raising costs. The worry now is that the government’s efforts to tackle inflation will squeeze growth. A hard landing may even be in the offing.
The authorities are taking further measures to clamp down on lending, which is likely to hamper corporate expansion plans and reduce revenue growth, as The Economist says, while it is also allowing the yuan to appreciate more rapidly. This will make imported goods cheaper but makes exports pricier – just as US consumers are tightening their belts, notes Cox.
In any case, says Citigroup, a US recession will put downward pressure on exports from China and on economic growth. Another factor causing concern is that cross-shareholdings have bolstered earnings in the domestic market. Jing Ulrich of JPMorgan reckons that investment gains comprised 22% of profits in the first three quarters of last year. So there is a risk of a cycle of reduced earnings growth pushing the market lower and further eroding earnings.
While the China story has lost some of its appeal, the long-term outlook in Taiwan appears to have improved. With the pro-China KMT party now in charge of both houses of parliament following last week’s presidential election, the stage is set for closer ties with China, already the island’s biggest trading partner. The new president Ma has pledged to dismantle a five-decade ban on direct flights between Taiwan and China and ease restrictions on local firms, which are currently barred from investing more than 40% of their assets in the mainland.
If the economy is fully opened to China, a “massive economic boom” would result, says Peter Sutton of CLSA. He sees scope for the market to gain about 20% by the end of next year. UBS is also keen on the theme, rating Taiwan a buy. Yet there may well be further falls in the short-term, given that half its GDP stems from exports. According to Tony Phoo at Standard Chartered, opening up to China is “not enough to shield Taiwan from a global slowdown”.