Credit Suisse Says Chinese Equities Have Returned to Fair Value
Chinese stocks have continued their steep decline, with the Shanghai Composite now down 29 percent from its June 12 high. This has prompted a number of measures from the government as it attempts to stem the rout, and also sparked many analysts’ attempts to figure out what comes next for this massive market.
Alexander Redman and Arun Sai at Credit Suisse are the latest to wade in.
The analysts say they’ve spent the past five weeks talking to investors in the U.S., Europe, and the Far East, and amid the preponderance of China-related questions (How damaging is the wealth effect of the burst bubble for the Chinese consumer? What evidence is there for any reacceleration in Chinese macro momentum?), one stands out: Have Chinese equities returned to fair value?
In an effort to answer that question, the team looked at four different approaches, all of which are based on pricing of MSCI China (which includes H-shares and B-shares) rather than domestically listed A-shares.
The first was a macroeconomic regression model for MSCI China. The team says this measure uses current levels of U.S. ISM new orders, Chinese industrial production growth, year-on-year growth in Chinese property transactions, and CPI inflation to predict market returns. The deviation is now less than 1 percent after indicating the market was 21 percent overbought at the peak in June 12.
The second was a look at earnings multiples. According to the note, MSCI China is trading on a sector-adjusted 12-month forward consensus earnings multiple of 9.5 times. That’s a 16 percent discount to the average over the past 20 years.
The third was breadth of earnings revisions. Redman and Sai say this has “recoupled with its long-run association with MSCI China year-on-year performance” after a disconnect in June. The analysts are referring to a detachment in the market earlier this year, when there was both strong performance momentum and a large number of negative earnings revisions.
Lastly, a number of technical indicators show the market is no longer in overvalued territory.
The first one the team looked at was the 200-day moving average and the percent deviation from it. As their chart shows, the market has seen a swift decline from trading at more than a 20 percent positive deviation from the 200-day moving average to a slightly negative one.
The next measure they looked at was the relative strength index for MSCI China, which you can see has quickly fallen out of overbought territory. This measure compares the magnitude of recent gains with recent losses, and analysts use it to help determine whether an asset is overbought or oversold.
Of course, whether the Chinese stock market is at fair value or not may have little bearing on investors’ attitudes toward it.
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