China: A-shares on fire, CNY strengthening, PMIs confirm softness

Markets

Chinese stocks on fire: China A-shares (onshore market) have rallied strongly over the past month being up more than 10%. Foreign focus has suddenly shifted from whether China was investable to concerns over a new bubble on the mainland. H-share stocks on the other hand have traded more or less sideways during August. Why the sudden rise in onshore market when data has been quite disappointing lately?

It is hard to point to one trigger but we have seen a confluence of factors coming together. First, on-shore stocks were lagging behind H-shares this year (chart 1) but suddenly in July and especially August played catch-up. Second, there is a lot of herd behaviour in the onshore market dominated by retail investors, which sometimes accelerates moves once the ketchup comes out of the bottle. Household deposits are massive after years of high savings (chart 3) and some of that money increasingly comes into the market when households start fearing to miss out. Third, positive headlines from tech company earnings and tech in general have added to the positive sentiment. Fourth, we saw a big jump in shares of chip producers following signals that Chinese authorities are warning against using Nvidia's H20 chips and it got more fuel when Nvidia was reported to have told suppliers to halt production of components of the H20 chips. Chinese chip company Cambricon more than doubled in value in August leading them to send out a warning of trading risk in the stock.

Bubble or not?  The onshore market is now at a 10-year high but with a forward P/E level around 15 it is hard to talk about a bubble at this point. With lots of more potential liquidity coming from more deposits, though, it is not impossible it will turn into the next equity bubble in China around the 10-year anniversary of the previous bubble. FOMO is a strong force andcan drive more investors into the market. The offshore index is more dominated by foreign investors and is still below its' long-term average despite the sharp rally this year of more than 25%. Hence, it is hard to talk about a bubble in this market. For now, the trend seems to be your friend as the macro environment is overall benign and still lots of money that can potentially enter the market.

CNY appreciation: USD/CNY has moved lower lately (chart 4) driven by a couple of factors: a) lower US yields that have narrowed the US-China yield spread, and b) PBOC guiding the cross down with a gradual lowering of the fixingfor some time. I look for some stabilisation as the decline in US yields looks stretched to us. However, there is some downside risk now to our 12M target of 7.12 as PBOC may be aiming for a further appreciation of the CNY as it would support the rebalancing of the Chinese economy towards consumption and accommodate outside pressure due to China's ballooning trade surplus. 

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