China’s bull run may have run out of steam. Last Friday, the country’s benchmark index slumped, raising concerns that stock gains had come in too fast and for too long. Market watchers also believed that a bubble had built up over time, pushing valuations to unsustainable levels.
Spectacular SlumpThis raises serious questions about the future of China’s equity markets. Government agencies may have to act quickly in order to stem the rout.
The Shanghai Composite Index nosedived last Friday, losing 6.4% at the end of trading. The benchmark index declined 13% over last week. After losing more than 10% from the high hit on Jun 12, the gauge is possibly indicating that a correction is in progress.
A measure of volatility rocketed to its highest level in nearly six years after 400 shares listed on the Shanghai exchanges declined. The CSI 300, which is made up of the country’s largest stocks, declined 6%. Sub-indexes of tech, telecom and industrial stocks within the index lost a minimum of 15% over last week.
The tech-heavy ChiNext slumped 5.4% and has declined 17% since it achieved a record high on Jun 3. The Hang Seng China Enterprises Index also moved lower, losing 0.6%. The Shanghai Composite declined at the sharpest clip compared to other global indices over last week. The slump comes after a 152% rise over the last 12 months, the highest across the globe.
Market Watchers Voice Concerns
Analysts and market watchers across the spectrum have voiced their concerns about valuations and the speed at which stocks have made gains. This includes key figures at Bank of America Corp. (BAC - Analyst Report), BlackRock, Inc. (BLK -Analyst Report) and Credit Suisse Group AG (CS - Snapshot Report).
They have highlighted the fact that China’s shares have gained nearly $6 trillion over the last 12 months. The bull run has been fueled by a substantial number of retail investors as well as record margin debt levels of $363 billion. Valuations have surged, with median stock valuations at 95 times earnings, compared to 68 at the peak of 2007’s feverish rush for stocks.
The benchmark’s gains had clocked up 928 days by Friday. It is a record level, the highest since trading began in 1990 and is five times or more than the average duration of earlier rallies.
The immediate decline was the combined effect of two factors. A series of IPOs had raised concerns about funds crunch. In fact, concerns over IPOs were not altogether unfounded. The 25 new share sales may have locked up more than $1 trillion according to one estimate.Government Intervention Likely
Meanwhile, a further cut in reserve-requirement ratios, expected to take place over the last weekend, failed to materialize. Disappointing data on exports and producer prices had created expectations that a third such reduction would take place this year.
Market watchers believe that this is an opportunity to purchase China stocks. It is widely expected that the government will intervene in order to boost equity markets. Among likely measures are adjustments in the new share sales schedule and changes in margin trading norms. Further action on President Xi’s initiative to foster overseas transport links could also boost investor sentiment.
Our Choices
Below we present three stocks which are still worth buying despite last Friday’s rout, each of which also have a good Zacks Rank.
China Petroleum & Chemical Corp. (SNP - Analyst Report), or Sinopec, is the second largest crude oil and natural gas producer, and the largest refiner and marketer of refined petroleum products in China.
Sinopec holds a Zacks Rank #1 (Strong Buy). The company has expected earnings growth of 11.9% for the current year. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 11.56.
China Lodging Group, Ltd. (HTHT - Snapshot Report) is an economy hotel chain operator in China. The company offers hotel products under three brands that are designed to target distinct groups of customers.
China Lodging Group holds a Zacks Rank #1 (Strong Buy). The company has expected earnings growth of 15.4% for the current year. It has a P/E (F1) of 29.87x compared to the industry average of 34.40.
China Life Insurance Co. Ltd. (LFC - Analyst Report) is China’s leading life insurance company. It is a subsidiary of China’s first insurance company, China Life Insurance (Group) Co.
Apart from a Zacks Rank #2 (Buy), China Life Insurance has expected earnings growth of 32.3% for the current year. It has a P/E (F1) of 18.94x.
Despite the current slump, China’s equity markets still present a good buying opportunity. If anything, the current downturn could be a good time to pick up stocks at lower prices. The world’s second largest economy still retains considerable strength and further government action to boost investor sentiment is likely. This is why these stocks would make for a prudent choice.
by Swarup Gupta
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