China’s Mini-QE Will Attract Investors

The People’s Bank of China, which is the Chinese central bank, has responded to the call of investment analysts to be more active. While it is not frantically purchasing distressed assets in the provinces deep in debt, it has lowered the reserve requirement ratios, with more still in the pipeline.

This allows banks greater room for lending, which has been on the decline for a while. However, the PBoC still has more ammo rearing in its mini-QE stock to keep the trend going. Investors that have watched the European Central Bank and the Fed with a hawk-eyed should turn their eyes towards China.

PBoC’s stimulus program comes in the footsteps of the ECB before it, and the stimulus is predicted to eventually make its way down to the prices of assets, including Chinese equities. For a third time in less than a half-year, PBoC last Sunday reduced the single-year lending rate to 5.1% and the single-year deposit rate to 2.25%, both reductions of 0.25 basis points.

Shanghai and Hong Kong stock prices are to rise this week as investors from China mainland pile into Hong Kong. For many, the Chinese stock market gains have become less fundamental and more of gambles. While the economy continues to grow, the pace has much declined.

Regardless, following the same trends of buying European stocks following ECB’s stimulus and wagering entire hedge funds following the Fed, China is likely to see the same increased investor activity despite the dreary rudiments.

The market was previously over-invested but this is no longer the case. The Hang Seng Index was 56.8 two weeks ago, and had declined gradually prior to that. The relative strength index, which is a measure of overselling/overbuying in stock markets, was over 70 throughout April, indicating the market was overbought. Oversold markets have RSIs below 30. Since late April and into May, the RSI has been declining.

Should the mutual funds of emerging markets begin to increase amounts allocation in China, the inflow towards H-shares in Hong Kong could rise to $26 billion? Research among clients and analysts suggests that such funds are under-invested in the Chinese market.

A report by Goldman Sachs (NYSE:GS) revealed that mutual funds in Asia, Japan-excluded, pure-play funds in emerging markets and the more differentiated global funds are less exposed to China by 600, 320 and 140 basis points as per given benchmarks.

Currently, stock prices in Shanghai and Hong Kong are at about half of the peak values attained in 2007, prior to the US financial crisis of 2008. However, by last week, the price earnings ratio in the Hang Seng Index stood at 11.7 times – viewed as an outrage in some circles.

However, this is not strange, since before the crisis of 2008, the PER had risen to as much as 21.07 times in Hang Seng.

Commentaries from China reveal that the national strategy is to develop a slow-but steadily growing market over the long-term, a strategy that worked well in the US, at least for a while. However, in time, China may witness the same rise in unemployment should government support be withdrawn from companies.

Nonetheless, as investors have done in chasing central banks in the past, they will probably follow the PBoC too.