Last year, most overseas investors were quite bearish in China as they worried about “hard-landing” of Chinese economy. Today, they found themselves over-pessimistic as the risk of “hard-landing” fell. Although it seems very risky to jump on the bandwagon of Chinese A shares after they rallied over 50% last year, there are some investment themes in 2015 that we shall not miss. We see three investment themes this year that can support further rallies in A shares.
Disinflation and lower interest rate
Though falling energy and commodity prices could hurt some domestic producers, we believe China, the largest net importer of commodity, will benefit from cheaper resources as a whole. According to National Statistics Bureau, China's latest CPI is around 1.6%, far below government's target of 3.5%. Lower inflation pressure gives more rooms for the PBoC to further loosen monetary policies. Lower prices also allows for energy and utility price reform by the government.
China CPI(Black) and PPI(Yellow)
Data Source: Bloomberg
We expect easing monetary policies would lead to lower risk-free rates. First of all, the first rate cut in November 2014 proved that the government did not consider rate cut as a taboo any more. Secondly, China has increasingly recognized the damage of high real interest rate to the economy. Recently, there have been more and more calls for measures to lower funding costs. So in 2015 the PBOC is likely to increase the amount of liquidity injection to deliver lower interbank rates. Last but not the least, the PSL, regarded as China's QE, could help lower the risk-free rate by lending the PBoC's money to local government via China Development Bank. Not only does lower rates avoid “hard-landing” of economy, it also eases financing difficulties of companies. It would help lift A share markets.
Local government funding vehicle reform
Local government debt has increased significantly since 2008. Many overseas investors are fear of their asset quality. Their concerns about defaults of local government debts would mean lower risk premium. Funding cost of economy also grew, crowding out private sector funding needs and increasing systematic risks of the financial market. Recognizing the negative effects, it is expected that the central government would take two steps to tackle the problem. First, it increases funding from central government-owned policy banks to support infrastructure and social housing projects directly. Secondly, it introduces new rules governing local government debt so that only provincial-level governments could issue bonds to raise money.
Equity financing to boost
Chinese companies, no matter state-owned or private, rely too much on debt and too little on equity financing. As authorities once suspended the equity IPO market, equity financing has been less effective than debt financing. That resulted in a rapid growth of corporate debts rather than equities. In 2015, the focus of the stock market is likely to be the change IPO issuance mechanism from approval-based to registration-based. The registration-based IPO issuance mechanism could make IPOs more market-oriented. At least, slow bull markets can attractive companies and arouse investors' interests.
In conclusion, we believe lower risk-free rate and higher risk premium will continue to lead to a bull A share market. At the same time, we will not see a great positive policy effect in equity regulation. However, investors should also be aware of two major risks in 2015. Markets would remain very volatile and roller-coaster-like movement is expected. Stronger RMB relative to non-USD currencies may also hurt China's export data, thus increasing concerns in Chinese economy.