Friday 29 Mar 2024
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SINGAPORE (June 30): China stocks rebounded strongly today after slipping into bear territory yesterday following the announcement of interest rate cuts and further monetary easing over the weekend. The  main barometer Shanghai Composite Index market was up over 5.5% today while the Shenzhen benchmark was up 5.6%. The two indices are up 108% and 95% respectively over the past year.

Now one of the Asia’s most respected equity strategists, Ajay Kapur of Bank of America Merrill Lynch, is calling the Chinese market way overvalued.

The way Kapur sees it, last Saturday’s moves by the People Bank of China’s Governor Zhuo Xiaochuan should not be seen as a sign of massive policy easing. “Monetary policy in China is still exceptionally tight, despite this weekend’s cut in interest rates and reserve requirements,” he notes. “ A combination of an appreciating trade-weighted currency, faltering loan growth and still rising real corporate bond yields – normally a great coincident indicator of A-share performance is still tight.” he said in report this afternoon. “Looking at nominal interest rates and inter-bank interest rates as an indication of “easing” suggests money illusion and a disregard for how debt deflations work,” he argued.

He cites the massive rise in China’s corporate debt from US$1.4 trillion ($1.8 trillion) in 2000 or around 83% of its GDP to US$12.5 trillion in mid-2014 or over 125% of  China’s GDP.

Kapur says it is wrong for investors to compare the current A-share bull market in China to similar stealth rallies  in Taiwan, Korea and Japan in the late 1980s citing similarities in “reform” and  capital market opening. “Those bubbles were driven by a massive increase in current account surpluses, that could not be sterilized fast enough, and with nowhere else to go, created equity and property bubbles,” he recalled.

The situation in world’s second largest stock market is very different from Japan, Korea, Taiwan in the 1980s, Bank of America Merrill Lynch strategist argues.  With its burgeoning corporate debt, “China has a debt deflation on its hands (which) requires corporate bond yields to be well below nominal GDP growth of around 5%,” he notes. This means that the policy rate should head to around zero percent. “Yes, it sounds radical, but so is the scale of China’s impending debt deflation and the magnitude of its debt binge,” he argues. Investors should look at fixed income which is “much more appealing in a debt deflation than equities,” he says.

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