by Craig Stephen
The Shanghai A-share index may be the world's second-worst performing equity market this year, but it is beginning to attract notice for the right reasons again, finishing last week up 6.1%.
A possible relaxation in government tightening measures which have rationed credit since the beginning of the year is the main reason for the move higher, although various analysts are starting to push cheap valuations on A-shares.
But it is changes in government policy that are under particular close scrutiny in an economy and equity market that is notoriously policy-driven.
Speculation is rising that recent weak economic data will force the government's hand into easing up on tightening measures. The release of second-quarter gross domestic product numbers earlier this month showed the economy slowing to a growth rate of 10.3% versus 11.9% in the first quarter.
Last week, Chinese President Hu Jintao said the government should stick to a proactive fiscal policy and moderately loose monetary policy in the second half of this year to ensure a stable and relatively rapid economic development. There was also a Xinhua news report that consumption stimulus measures will be implemented in the second half, which sounds like Beijing is ready to up the pace a little.
Deutsche Bank, in a new economic report, asks if this is the "turning point" in China macro policies? It expects economic numbers on the mainland will worsen in the next two to three months, but it is not expecting Beijing to loosen policy until the fourth quarter.
Still, if Beijing is ready to alter course and put its foot back on the accelerator, investors may want to position now.
Deutsche Bank concedes there is a very mixed bag of signals on the economy and says the chance of missing out on a huge A-share rally from now is limited.
There are, of course, various challenges facing policy makers -- from a property bubble and an uncertain outlook for exports into a fragile global economy, to fears over bad loans.
But in the meantime, money has to go somewhere. Already some brokers are getting off the fence to proclaim bullishness on Chinese shares.
Nomura, in a recent strategy report, upgraded its outlook for A-shares, saying they are inexpensive on valuations and attractive, relative to domestic deposit rates.
The bank argues that liquidity conditions and inflation expectations dominate the performance of the A-share market.
In particular, Nomura highlights the impact of deflationary expectations with respect to property and asset prices, which has led to an increase in cash holdings by local investors. This means that one consequence of measures to curb property prices is investors are now on the lookout for another place to put their money.
With bank deposits paying little over 2.5%, and investment options in China severely restricted by the state, the stock market is again starting to look attractive.
Another support for A-shares is that, after recent falls, valuations now look cheap on a historical basis. Nomura calculates that on a price-to-earnings basis, the CSI 300 is now approaching a 15-times multiple versus an average price earnings ratio of 22.9 times. Macquarie Equities agree valuations are low, calculating that on a forward-earnings multiple, Shanghai A-shares are trading at just 13.2 times.
One caveat, however, is that if valuations are getting cheap, you would expect an improvement in dividend yield. Unfortunately, this is not the case, with Nomura measuring dividend yield on the CSI 300 at 1.5% versus a historic mean of 2.6%. Mainland Chinese companies in general are still poor at paying out decent dividends.
Meanwhile H-shares in Hong Kong should be watched as a proxy for any strengthening of A-shares. Another interesting trend is the narrowing of the traditional A-share premium over H-shares. It now stands at just 0.7%, Macquarie notes, versus a long-term average of 28.6%. Nomura highlight that A-share tracker-funds have also begun to trade at a premium.
Looking ahead, government policy will be carefully watched for any confirmation of policy loosening or new stimulus by Beijing. Still, perhaps the most important signal to watch for is evidence mainland Chinese retail investors are returning to equities.