China has been the world’s best-performing stock market since late last year, and we believe, will continue to be a very good one for a few more months.
Why has the performance of Chinese stock markets been so strong? Simply because the Chinese government has taken many actions to make the markets move higher.
Recently there have been more actions, and on April 27, Reuters in Hong Kong reported that China would soon initiate a round of Chinese quantitative easing, with the Peoples’ Bank of China (PBoC) purchasing assets from commercial banks so as to support an upcoming “local government debt swap program.”
The government is not yet on the record supporting or denying this news. If it is true, it will initiate a very strong program to force liquidity into the Chinese market and to solve the problem of local governments’ bad debts by having the central bank taking those bad debts onto its own balance sheet. (As we have observed before, it’s an extremely strong balance sheet, well able to handle the stress.)
This will:
1. Help Solve the obvious problem of local governments’ bad debts.
2. Close another door to corruption and the misappropriation of government assets. Much of the bad debt was created when corrupt officials borrowed for projects that were never finished and the government money was misappropriated -- the total refinancing will probably amount to 3.5 to 4 trillion Yuan ($550 to $650 billion), about twice as much as projected early in 2015. This would be a massive expansion of money supply to meet government bond issuance. This will keep money supply at above 15 percent growth rate in the second half of 2015.
Equally important, Xinhua News announced that China plans mergers to cut the number of big state firms -- state owned enterprises, or SOEs -- to 40 from over 115. The purpose of this is, in our view, to cut inefficiency, to reduce corruption, and to make these companies more important instruments of government policy -- acting to China’s advantage in world markets.
Currently many SOEs’ assets are mismanaged; there is huge inefficiency and bureaucracy, and they have been growing too slowly. The government does not want to lay off employees; they will keep all of their employees, but they will be managed for much more efficient operation. The goal will be to make them more like privately held companies in terms of operating results.
More than one major securities firm believes that Chinese interest rates will fall several times again this year. With all of this enthusiasm, is it hard to imagine that after hitting a speed bump in the next few weeks, China will fail to move significantly higher by the end of the up cycle.
We remain bullish on China over the intermediate term, and would use any market corrections as buying opportunities.
Investment implications: Chinese stocks are the star performers of world stock markets. We believe that although they may be vulnerable to a near-term correction, they will resume their rally on the basis of continuing and widening government support -- with new measures possibly including the restructuring of SOEs and measures to deal with local governments’ bad debts.