beyondbrics

It’s the liquidity, stupid. Chinese A-shares listed in Shanghai don’t trade on fundamentals, global sentiment, or capital flows pouring in from overseas. It’s all about access to cash.

China’s attempts to reign in record bank lending this year put a squeeze of the availability of funds for plucky Chinese investors eager to snap up stocks (some might even say speculate). But the resulting fall in Shanghai share prices is leading some investors into a U-turn on A-shares.

This week analysts at RBS swung their call on the Chinese mainland market from a sell to a buy, raising their recommendation to ‘overweight’ from ‘underweight’. As Bloomberg reports:

China’s “relative valuations, liquidity conditions and ownership levels are now more attractive after a long period of substantial underperformance,” Emil Wolter and Dylan Cheang, Singapore-based analysts at Royal Bank of Scotland,

They aren’t the only ones feeling bullish on A-shares – the Shanghai listings of Chinese companies, which are difficult to access for foreign investors. Jing Ulrich at JP Morgan is also pushing the idea that Shanghai is set to gain in the coming months. She points to the premium paid for A-shares over H-shares (the Hong Kong listings of Chinese companies that are open to foreign investors), which has sunk to near parity, having been over 40 per cent as recently as the summer of 2009.

Foreign cash is certainly still flowing in China’s direction – data from EPFR for the past week shows continued buying across emerging markets, including into China-only funds. And FDI figures (admittedly not linked to equities) show investment topping $74bn in the first nine months of the year.

The market is responding. The Shanghai Composite moved into bull market territory this week having now gained over 20 per cent since its last trough (in July) – a commonly used measure of a bull market.

The index remains the region’s worst performer this year – down 10.4 per cent in 2010, weaker even than Japan’s Nikkei 225. But if it extends its rally beyond its current seven consecutive days, it may soon lose the label as Asia-Pacific’s laggard.

As always with the Chinese equity market, there’s a caveat. International finance houses may be bullish on mainland Chinese shares, but they remain bit players in the market. The direction of the Shanghai index remains tied to capital availability, local investor sentiment, and policy measures designed to cool whichever of the scarce asset classes open to Chinese investors is deemed by Beijing to be too hot.

China is trying hard to make sure the renminbi isn’t seen as just a one-way bet. If the bulls start running the show in Shanghai, could equities follow?

Related reading:
Do Chinese equities lead the world?
Is China’s market oversold, or overbought?
‘Liquidity Wave’ to Boost China, Asia Stocks, RBS Says, Bloomberg