Bear market in China: mainly due to Trump

Great concern is weighing on the Chinese equity market: since its high in January the Shanghai Composite Index has corrected by over 20%. Investors have sold shares because of concern that Chinese companies would suffer increasingly in the future from the trade disputes with the USA. Indeed, US President Trump’s protectionist policy is essentially targeted at imports from China. Despite the fall in share prices since the beginning of the year the Chinese equity market is still the second-biggest market in the world with a market capitalisation of USD 6.5 trillion (compared to Germany’s USD 2.3 trillion) even though it lags the US equity market by the huge amount of USD 31.1 trillion.

Because Congressional elections are due to be held in the USA at the beginning of November, we assume that President Trump will keep up his sharp rhetoric on trade with China and the EU until these elections. This does not bode well for the Chinese share indices and market sentiment is likely to remain depressed.

Disruptions to world trade would hurt companies in China. However, a clear difference should be made between the poor investor sentiment in the markets and the latest measures’ fundamental effects: even though our economic forecast is sceptical about China’s economic growth in the second half of the year (the total volume of planned US penal tariffs corresponds to two per cent of Chinese economic product), the repercussions of the trade dispute on China’s listed companies should be minor. The dependency on US business at the companies in the CSI 300 index (“China Securities 300”), which plots the price performance of the 300 biggest shares traded on the two mainland exchanges in Shanghai and Shenzhen, is very limited. An analysis of the ten biggest stocks, which together account for 25% of index capitalisation, shows that these companies generate less than five per cent of corporate sales revenues in the USA. The significant shift in China’s economy towards the domestic market and the increased diversification of its trading partners mean that companies today are less vulnerable to disruption of direct trade with the USA than they were just a few years ago.

But the situation is different in those sectors that make a major contribution to China’s large trade surplus with the USA. These include companies from the home electronics, manufacturing, automotive components and textiles sectors. Their fundamental outlooks have deteriorated significantly, most of their share prices will probably have fallen, and rightly so.

The valuation ratios of the Chinese market have improved, corporate profits should remain stable. At the moment, the P/E valuation is 11.7 points and profits probably grew by nearly 13% in 2018. However, sentiment is likely to continue to have a negative impact on Chinese shares for some time to come. In particular, the trade dispute with the USA could intensify in the next few months. The ongoing uncertainty is likely to stand in the way of any sustained equity market recovery. For this reason, we believe the Chinese equity market is not yet attractive enough for investments at the moment.

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