China Stock Boom Has Morgan Stanley Ready for ‘Ultra-Bull

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Mainland Investors
Investors monitor and trade stocks at a securities exchange in Shanghai, China. Mainland investors are opening stock accounts at the fastest pace in three years, trading in Shanghai has surged to an all-time high and initial public offerings have returned an average 180 percent in 2014. Photographer: Qilai Shen/Bloomberg

That bull-market feeling is back in China.

The Shanghai Composite Index’s advance to a three-year high today extended its gain over the past month to 14 percent, trouncing all 92 of the world’s other benchmark equity indexes by at least six percentage points. Mainland investors are opening stock accounts at the fastest pace in three years, trading in Shanghai surged above 500 billion yuan ($81.3 billion) today for the first time and initial public offerings have returned an average 180 percent in 2014.

Central bank efforts to bolster China’s economic growth are reviving optimism in the $4.6 trillion stock market after the Shanghai Composite lost more value than any other major benchmark index worldwide in the past five years. While exchange-traded fund investors are paring holdings on concern the gains won’t last, Morgan Stanley says there’s potential for an “ultra-bull” rally where share prices double in 18 months.

“New account openings are a sign that there is fundamental investor participation,” said Jonathan Garner, the Hong Kong-based head of Asia and emerging-market strategy at Morgan Stanley who predicted in June that monetary stimulus would drive a second-half rally in Chinese shares. “Moves on high volumes should always be taken seriously.”

Locals Buy

Garner says his ultra-bull scenario is predicated on low returns for investment alternatives such as real estate, a “soft landing” for China’s economy and a transition to a growth model geared toward domestic consumption and services. Investors should favor “new economy” industries such as health care and technology, along with financial stocks, Garner said in a phone interview yesterday.

The Shanghai Composite rose 0.6 percent to 2,779.53 at the close as turnover reached a record 529.4 billion yuan. The MSCI Asia Pacific Index was little changed.

Individual investors in China are adding to their stock holdings, with some borrowing money to amplify their purchases on expectations the rally will continue, said Chen Xiaofei, an investment adviser at Changjiang Securities Co. in Shanghai.

“Our margin trading business has almost doubled,” Chen said. “Individual investors I’ve contacted think this is the beginning of a bull market and they are shifting money into stocks.”

ETF Outflows

Such optimism is a turnaround from just three months ago, when the number of stock accounts containing funds dropped to a more than four-year low of 52.4 million. The Shanghai Composite had tumbled 23 percent from its August 2009 high through a month ago for the biggest retreat among benchmark indexes in the world’s 40 largest markets.

The number of funded accounts has since climbed by about 425,000 while the four-week average of new account openings increased to the highest level since April 2011 last month.

Not everyone is convinced the rally is here to stay. Investors pulled about $845 million from the CSOP FTSE China A50 ETF, a Hong Kong-listed fund that tracks mainland shares, in the two weeks through Nov. 28, the biggest outflow since the fund was started in 2012. The iShares FTSE A50 China Index ETF lost $585 million last week, the most since 2009, while foreign buying of Shanghai shares through the Hong Kong exchange link has slowed since the program’s debut on Nov. 17.

The Shanghai Composite’s 14-day relative strength index climbed to 88.1 today, the highest level since January 2007 and above the threshold of 70 that some traders use as a signal that gains are poised to reverse. When equity turnover in Shanghai approached current levels in 2009 and 2010, it coincided with market peaks, according to data compiled by Bloomberg.

Alternative Investments

China is headed for its slowest full-year economic expansion since 1990 amid a property slump, weakening industrial output and a jump in bad debt. Non-performing loans surged 10 percent last quarter, according to the central bank.

Stock valuations in China are still low after the rally, according to Garner. The Shanghai gauge trades for about 1.7 times net assets, a 17 percent discount versus the MSCI All-Country World Index, data compiled by Bloomberg show. The Chinese measure has been valued at a 24 percent premium on average during the past decade.

Low bank rates, falling gold prices and a weak Chinese property market have increased the appeal of equities for mainland investors, said Shi Cortesi Jian, a Zurich-based money manager at Swiss & Global Asset Management Ltd., whose parent oversees about $130 billion.

Stimulus Speculation

The central bank cut its benchmark one-year deposit rate by 25 basis points to 2.75 percent last month, while bullion touched a four-year low last month and new home prices fell in all but one city monitored by the government in October. China’s government sold debt at a higher yield than analysts forecast today, a sign of weakening demand.

“For Chinese investors, there’s always that asset allocation question of where do you put your money?” Shi said. “With equities being cheap, some of the stars are aligned.”

Yesterday’s 3.1 percent surge in the Shanghai Composite was spurred by speculation that the central bank will loosen monetary policy further to support economic growth.

“There’s quite a lot of upside” for stocks, Tommy Ng, a distribution channel relationship manager at CSOP Asset Management Ltd., which runs the $5.8 billion FTSE China A50 ETF in Hong Kong. “We should be very optimistic.”

— With assistance by Allen Wan, Shidong Zhang, and Kana Nishizawa

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