China-related markets seeing light at end of tunnel
Updated: 2011-04-28 06:44
(HK Edition)
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More than one month after the Japan earthquake, emerging markets are superseding the leadership of their developed counterparts. China-related indices - Shanghai A and Hang Seng CEI - have outperformed, and I believe the trend will continue throughout this year.
After the earthquake and nuclear crisis in Fukushima, market expectations for liquidity has changed. The Bank of Japan has injected huge liquidity into the markets through an asset purchasing program of $500 billion.
With a cap on the yen placed by the G7, the surge in capital supply encourages carry trade activities, which helps stoke the appetite for risky assets. High-yield currencies such as the Australian dollar took the lead, which jumped to a historical high. And emerging markets followed.
However, lightning never strikes twice in the same place. This time, liquidity picks last year's losers. That is the reason why China-related equities outperform now.
It could be attributed to the expectation of fadeout of policy headwinds. Lingering worries over inflation is about to taper off since there are some signals indicating that economic growth has started to slow down. Coupled with previous administrative measures, further harsh tightening could induce a negative surprise in the economy.
A post financial crisis recovery always generates tremendous growth figures because of the low base effect. However, almost three years after the nadir, the base effect has been dissipating and restrictive policies have come into effect. Although we saw a rebound to 52.5 in March, China PMI remains at a comfortable level that would not contribute too much to inflation concerns. Some unofficial indicators which are closely tracking growth momentum also indicate that the economy is no longer under the threat of overheating.
The latest CPI reading has shown some pricing pressure. It hit a high of 5.4 percent in March. However, compared with other emerging markets, China is the pioneer in implementing tightening fiscal and monetary measures. Money supply (M2) has already slowed down to 16.6 percent from an average of 19 percent in 2010, and loan growth is also following a falling trajectory which is now at 17.9 percent.
Under the macroeconomic trinity of growth, exchange rates and inflation, it is unlikely - if not impossible - to have high growth, currency depreciation and low inflation at the same time. To contain inflation and avoid drastic currency appreciation, a portion of economic growth must be forfeited. Recent growth has been decelerated to a single-digit level from 10.3 percent last year after a string of tightening measures. Therefore, with food-price-led inflation likely peaking this summer, we expect to see more gentle gestures in upcoming tightening policies and the yuan should play a more important role in alleviating inflationary pressure.
By nature, the equity market is forward looking. The lackluster performances in the past two calendar years mirror the economic slowdown that started surfacing this year. Policy headwinds are beginning to wane and investors have already been paralyzed with the least aggressive measures. Any surprising fadeout of price pressures would be a catalyst to the market.
According to a research report from Morgan Stanley, China will be the first emerging economy to return to a neutral monetary policy over the next 12 months. With the support of liquidity from carry trades, China-related markets are now facing a favorable backdrop whereas most of the major markets have started feeling the heat of inflation and are ready to hike interest rates. China-related markets have seen the light at the end of the tunnel.
The author is a research manager at Alroy Financial Services Ltd, an independent financial services provider. The opinions expressed here are entirely his own.
(HK Edition 04/28/2011 page2)