As our regular readers know, we like to point out that the Chinese stock market’s performance is much more closely related to retail investor sentiment than are other major world markets. This is because the Chinese domestic stock market (“A sharesâ€) is relatively small compared to the Chinese economy, relatively underdeveloped as a component of the Chinese financial ecosystem, and still relatively closed to outsiders. All of these characteristics of the A-share market are gradually changing — but only gradually.
Chinese retail investor sentiment often responds to government statements and government policies. Perhaps the “wealth effect†is particularly pertinent in divining the mood of these investors and speculators. Other stars must align — for example, they must perceive that the central government’s attitude towards the stock market is at least tolerant and preferably supportive. But their feeling that the value of their home is rising is a critical component of the arrival of “animal spirits†in domestic Chinese stocks.
The chart below shows the year-on-year percentage increase in commercial residential real estate in China’s 70 largest cities.
Source: Bloomberg, LLP
You can note the steep decelerations that correspond with periods of financial tightening by the central government, and note as well that the recent tightening period, in 2017 and 2018, was shallower than those in 2011/12 and 2014/15. (Index data go back to the beginning of 2011.) Mid-way through 2018, when the Chinese government reversed its tightening stance and began to ease, the index turned up again.
The Shanghai Composite index, with a typical lag, bottomed on January 4 of this year, in expectation that the real economy would begin to respond to stimulus and reaccelerate later in 2019, and has rallied strongly since then.
The continued momentum of Chinese residential real estate is another factor that makes us bullish on domestic Chinese equities.
Investment implications: We remain bullish on Chinese A shares for reasons discussed in previous letters: central government easing, official pronouncements supporting domestic sentiment on stocks, the expansion of A shares in influential global stock indexes, a more friendly regulatory environment for some big companies, and acceleration in residential real estate price appreciation. We note that the Chinese market has made a big move since its January bottom and we would not be inclined to chase it here. As long as the policy and macro environment remain benign, we regard corrections in A shares as buying opportunities.
