Photographer: Qilai Shen/Bloomberg

China's Stock Rally May Run Out of Steam Next Year

Updated on
  • Analyst who called boom and bust sees rotation into small caps
  • Shanghai Composite to trade between 2,800-3,900, Hao Hong says

China’s benchmark stock index will trade weaker than current levels for much of next year as an official deleveraging campaign crimps credit growth and keeps interest rates elevated, according to Bocom International Holdings Co.’s Hao Hong.

The Shanghai Composite Index will move between 2,800 and 3,900 for the next 12 months, with brief episodes of volatility driven by changes in liquidity conditions, Hong wrote in a research note to clients. That compares with a current level of around 3,300. Large cap stocks have surged in 2017, and their valuations are approaching extreme levels, he added, predicting a “zig-zag” rotation into smaller peers.

Next year will again “prove to be a structurally diverging market, and traders will once again have to work within the constraints of limited liquidity,” said Hong, who distinguished himself as one of the few analysts to forecast both the start and 2015 end of China’s equity boom. “Contrary to the experiences of 2017, small caps will likely be back in favor. Selective large caps should continue to do well, but the difficulty of picking the right stocks within this group will be increasing.”

China’s larger companies have outperformed on the mainland this year, with the CSI 300 Index surging more than 21 percent. The nation’s small-cap ChiNext Index -- traditionally more vulnerable to tougher regulations and higher borrowing costs -- has dropped over 8 percent.

Government efforts to cool gains in some top performers have hit sentiment toward domestic equities, while a bond rout driven by the deleveraging campaign has added to the pressure. The nation’s 10-year sovereign bond yield surged 35 basis points in the two months through Nov 24, before moderating a bit last week.

The debt decline will continue, Hong wrote, before possibly easing off in the first quarter of next year. Tightening regulations on shadow banks have helped arrest credit growth, and its drag on economic growth will gradually emerge, he predicted.

— With assistance by Tian Chen

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