Chinese stocks – finely balanced

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In a surprise move on Christmas day, the People’s Bank of China (PBOC) increased its key one-year lending and deposit rates by 25 basis points. The hike pushed China’s benchmark lending rate up to 5.81%, compared with 7.47% prior to rate reductions from late 2008 to counter the global financial crisis.

“These policy moves could be front-loaded in coming months, as headline inflation figures remain high and economic growth faces overheating risks early next year,” said Wang Qian, JP Morgan’s Hong Kong-based chief China economist (via Bloomberg). According to the median forecast in a Bloomberg News survey of economists, the lending rate will climb to 6.56% by the end of 2011.

Showing disappointment with the size of the increase, investors sold Chinese stocks this morning, pulling the Shanghai Composite Index 1.9% lower – its largest decline in a month’s time. Fears of monetary tightening have been weighing on the Chinese stock market for a while, resulting in significant underperformance against both emerging markets and mature markets, as shown by the year-to-date performance in the table below.

Click here of on the image below for a larger graph.

Source: StockCharts.com

The chart below shows the Shanghai Stock Exchange Composite Index trading above its key 200-day moving average (blue line) but below the 50-day average (red line). The Index is also squeezed into a triangle, indicating a point of resolve could be expected over the next week or so.

The Chinese (and Hong Kong) stock market was the first to turn the corner after the credit crisis sell-off – a full four months before the majority of indices bottomed in March 2009 – and is being watched closely to ascertain whether this market could be spelling danger for global stocks. The bottom panel in the following chart shows that the Shanghai Composite Index has been underperforming the Dow Jones World Index (i.e. a proxy for mature stock markets) for the past 18 months:

Source: StockCharts.com

Still on the topic of underperformance, the chart below, courtesy of Doug Short, illustrates the comparative performance of world markets since March 9, 2009. “The start date is arbitrary: The S&P 500 hit a low on March 9th, the Nikkei 225 on March 10th, the DAX on March 6th, the FTSE on March 3rd, the Shanghai Composite on November 4, 2008, and the Hang Seng on October 27, 2008. However, by aligning on the same day, we get a better sense of the present-day synchronous behavior of the markets than if we align the lows,” said the report.

Click here of on the image below for a larger graph.

Source: dshort.com, December 26, 2010.

http://dshort.com/charts/World-Markets-Update.html?World-Indexes-since-090309

No reason to be overly concerned yet, argues Eoin Treacy (Fullermoney) from across the pond: “There is no argument that the Chinese economy faces challenges just like every other, but there is no reason to believe that China is any less capable of dealing with its problems than those in the so-called developed world.”

To which his colleague David Fuller adds: “People fear China’s credit tightening might trigger another significant sell-off in world markets. China’s monetary policy authorities need to get the balance right if they are to stem inflation and property speculation without overkill. This can be a fine balance but they have every incentive to succeed and their gradualist (baby-steps) approach to monetary policy tightening seems prudent. They will make some mistakes, like everyone else, but this is a medium-term risk and should have little effect on China’s long-term potential.”

Commentators are still focusing on the extremely weak OECD Leading Indicator for China and the potential effect thereof on the Chinese stock market. My proprietary Monthly Smoothed Annualized Growth Rate (MSAGR) of the Shanghai Composite Index has bottomed in negative territory, though. It indicates to me that yes, economic growth is likely to slow in the next few months but it could be short-lived as the smoothed growth rate of the Shanghai Composite Index is again approaching positive territory.

Sources: I-Net; Plexus Asset Management.

Needless to say, I will be watching developments during the Year of the Rabbit with more than a cursory glance.

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