Confused by the post-tariff China stocks rally? Take a look back to 2015

CGTN Published: 2018-09-30 17:54:24
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Some investors were probably not surprised when US President Trump imposed a further round of import tariffs worth 200 billion US dollars on Chinese goods, but a rally of more than six percent in Shanghai stocks since those tariffs were announced definitely surprised everyone. Still remember the crazy Chinese bull market in 2014-2015? Analysis shows that some of the catalysts from then may have reappeared to some extent.   

An investor looks at an electronic board showing stock information at a brokerage house in Shanghai on September 7, 2018. [Photo: VCG]

An investor looks at an electronic board showing stock information at a brokerage house in Shanghai on September 7, 2018. [Photo: VCG]

To be frank, Chinese stocks were traded irrationally back then, with extremely high leveraging activity one of the main factors that spurred on the bulls. 

Still, there were three other fundamental reasons, with stock market internationalization, the central bank's liquidity injection and infrastructure investment among the top catalysts. 

The fact is that those three factors may have returned once again, contributing to the stock gains seen in the past few days. 

Stock market internationalization

The huge rally in Shanghai stocks a few years ago started in November 2014, the same month that the Shanghai-Hong Kong Stock Connect system was launched. 

Given the low participation rate among foreign investors and huge domestic speculative flows in mainland markets, such a program would theoretically balance all types of investors and overhaul the Chinese capital market gradually, improving the investment atmosphere over a period of time.  

Earlier this week, MSCI released a statement saying that the index provider proposed an increase to the inclusion factor of large cap securities, from its current 5 percent level to 20 percent in two phases next year, while adding mid cap securities with a 20 percent inclusion factor in 2020. 

Although those inflows are relatively small compared to the Shanghai stocks' trading volume, it should help balance the nation's capital flows, after capital outflows accelerated in the past few years. 

A meaningful inclusion would help to send billions of dollars flowing into the A Share market, while more balanced cross-border flows would increase flexibility for the People's Bank of China implement its monetary policy. 

Signs of infrastructure investment

Copper is one of the key materials in infrastructure building, and China is the world's top buyer. Its price has fallen by almost 20 percent in the first eight months of the year due to slowing Chinese industrial demand. However, copper prices have recovered by over 5 percent since early September.

Copper rods are seen at a factory. [File Photo: VCG]

Copper rods are seen at a factory. [File Photo: VCG]

One valid explanation behind the rising price is that China has stepped up its infrastructure investment in a bid to counter external uncertainties from trade frictions.

Due to a slowdown in Chinese growth five years ago, copper prices began falling in 2014. Prices however started to rebound in January 2015, reaching a peak five months later.

Meanwhile, Shanghai stocks reached their peak in June 2015 before retreating sharply.

Data analysis shows the correlation between the Shanghai Composite Index and copper prices hit 0.81 in the past five years, and that may well explain why the recent rally in stocks is partly down to increasing industrial demand. 

In recent days, property and financial sectors led the gains in Shanghai stocks, which again could be signs that the nation has stepped up fiscal stimulus and infrastructure spending to boost domestic demand. 

Accommodative monetary stance

Despite the weakening yuan and narrowing China-US bonds yield spread, the PBOC didn't follow the Fed in raising interest rates this week. 

The Chinese market will be closed during the October 1 Golden Week holiday period, but thin liquidity in the offshore market may disturb the holiday peace because directional moves may become more exaggerated. 

That could see the offshore yuan weaken above the key level of 6.9 versus the dollar if the greenback continues to move higher. A looser monetary stance may risk pushing the offshore yuan above 6.9 next week. Since the PBOC decided not to follow the Fed's rate hike, it may convey the message to the market that monetary policy will be more growth-oriented, and its tolerance for the yuan's weakness could increase a little for the time being. 

In the PBOC's latest easing cycle, it started to cut the benchmark lending rate in November 2014, coinciding with the time when Shanghai stock prices began to take off. 

What's next? 

These three reasons may explain the recent Shanghai stocks rally, in spite of the escalation in trade tensions. It should be highlighted that the stock rally in 2014-2015 lasted less than nine months, as the impact from stock market internationalization, the central bank's liquidity injection and infrastructure investment didn't stay for long. 

Therefore, before we see a meaningful growth improvement and de-escalation in trade tensions, this current stock rebound could again be short-lived.  

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