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24 January 2017China Market StrategyHao Hong, CFAThe Year of the Rooster: A Trend Breaker?hao.hong@bocomgroup.comSummary: The ChiNext has violated its secular rising trend. Investors should take note. Credit spread historically has beenclosely correlated with the relative performance of large versus small caps. The spread has widened, concurrent with theunderperformance of small caps. The market has started to differentiate the quality of companies. The reprieve in the ChiNextwill likely be technical in nature only, and the tides have turned. Tighter liquidity will make ChiNext’s rich valuation an even moreacute issue. Price/EBITDA and market geometric return are peaking in the US, similar to the Asian Financial Crisis and RussianDefault around 1998, the TMT bubble in 2000, the subprime crisis starting at the end of 2007, and just prior to the Great ChinaBubble bursting in mid 2015. It bodes ill for overseas markets.-----------------------------ChiNext’s rising trend has broken. Recently, the ChiNext has violated its long-term rising trend, with intraday plunges of over 6%(Focus Chart 1). But the trend in Shanghai Composite has withstood the test, and the tendency of doubling every decade, whichhas been consistent with China’s growth target embedded in the Five-Year-Plans, persists (please see our report “The MarketBottom: When and Where?” on June 6, 2016. Focus Chart 2). Now the important question is which trend to trust?Focus Chart 1: ChiNext’s rising trend is breaking down.Source: Bloomberg, Bank of Communications (Int’l)The market has started to differentiate the quality of companies. Pundits were quick to explain the ChiNext’s recent plunge.Some believed that the accelerated pace of IPO was to blame. But the amount raised by IPOs in 2016 was only RMB 150bn in amarket valued at well above RMB 50tn and turning-over RMB 500bn daily, although the number of IPOs has grown. Further, thistheory does not explain why the large caps have held steady, despite the volatility in ChiNext. Potentially, however, decliningreturn from IPOs could induce liquidation in some positions held to be qualified for the IPO lottery, and thus represents anoverhang on the market.Some believed that the looming unlocking of private placements would strain market liquidity. True, private placementsamounted to over RMB 1700bn in 2016, and their unlocking would drain some liquidity. But the time of unlocking was scheduledDownload our reports from Bloomberg: BOCM〈enter〉
China Market Strategy24 January 2017well before hand, and thus could not explain the sudden plunge. And the divergent performance between large and small capsremains a puzzle.Focus Chart 2: The Shanghai Composite on track to double every ten years.Source: Bloomberg, Bank of Communications (Int’l)We note that credit spread between lower-grade bonds and treasury has surged. That is, the credit market is starting to demanda much higher premium on companies with lower credit ratings. The credit spread historically has been highly correlated withthe relative performance of large versus small caps, both in China and in Hong Kong (Focus Chart 3). Intuitively, as the financingcosts of lower-quality companies start to surge when treasury yields are rising and credit spread is widening, the return on theirstocks will suffer. When the market is bullish and is flush with money, this may not be a hindrance to small caps. But in a bearmarket as it is now, stock prices should start to reflect the quality difference between companies.Focus Chart 3: The market is starting to price in difference in company quality.Source: Bloomberg, Bank of Communications (Int’l)While the ChiNext seems to have double-bottomed at the level where it plunged to after the stock market bubble burst in 2015,the credit spread and treasury yield (risk-free rate) should continue to rise in the coming months. As such, any bounce in theChiNext will likely remain technical in nature within a longer-term trend that has now reversed.Download our reports from Bloomberg: BOCM〈enter〉2
China Market Strategy24 January 2017Euphoric sentiment in overseas markets bodes ill near term. Two important measures of market sentiment in the US, namely,the market geometric return and the Price/EBITDA ratio of S&P 500 are peaking (Focus Chart 4). The market geometric return isan equal-weighted return index. It gives more weight to smaller caps when calculating the return. Its peaking suggests that smallcaps’ return relative to large caps has been significant, and suggests reckless risk-taking. The meaning of peaking Price/EBITDAfor S&P 500, a type of quasi cash-flow valuation, is palpable. Similar phenomenon occurred in the Asian Financial Crisis andRussian Default around 1998, the TMT bubble in 2000, the subprime crisis starting at the end of 2007, and just prior to the GreatChina Bubble bursting in mid 2015. Euphoric sentiment tends to augur ill for the market.Focus Chart 4: Geometric return and valuation are peaking in the US, suggesting euphoric sentiment and auguring ill.Source: Bloomberg, Bank of Communications (Int’l)Download our reports from Bloomberg: BOCM〈enter〉3
China Market Strategy24 January 2017A review of our calls in 2016: We estimated that the trading range for the Shanghai Composite in 2016 was between 2500 and3300 (“Outlook 2016: the Chinese Curse” December 9, 2015). In January 2016, the Composite plunged to 2600 after the circuitbreaker triggered sell-off induced by the second round of RMB devaluation. It then peaked at 3301 intraday on November 29,2016. Our hits and misses in 2016 are summarized in Focus Chart 5 and 6, with report titles and dates in bold. Red color denotesmore cautious views at the time of reports. We are glad that we have more hits than misses, and we wish you and your family agreat Year of the Rooster.Focus Chart 5: The Shanghai Comp has traded between 2600-3300 in 2016, within our estimated range of 2500-3300.39002015/12/9 Outlook 2016: The Chinese Curse Buy governemnt bonds, not stocks in 2016. SHCOMP'sfair trading value 2,900 /-400. US dollar strengthening suggests looming market crisis.37002016/1/21 WeakHands: volatilitycontinued; wait fora better entrypoint35002016/4/18 Sweet and Sour Hog Cycle Rally stretched, andrisks are escalating. bearish trading setup for commodities2016/6/6: The Market Bottom: When and Where Marketbottom should be defined relative to a long-termeconomic growth rate; Shanghai's 2016 bottom ataround 25002016/6/13 The Great China Bubble:Anniversary Lessons and OutlookLooming global volatility. Bullishtrading setup for Commodities3300310029002016/9/12 The Most CrowdedTrade Looming HSI correction.2700Bearish on bonds2016/11/7 Global Hedge Fund West LakeSummit Inflation returns; the end of thesecular bond bubble.25002016/12/5 Outlook 2017: High-Wire Act Bonds to Underperform Equities; Volatility to Rise. strengtheningDollar, rising inflation and long bond yield, weakening CNY. Shanghai Comp likely trading range 3300 /500. But with wider return dispersion. Further, 2/3 of the estimates are lower than 06/201607/201608/201609/201611/201612/2016Source: Bloomberg, Bank of Communications (Int’l)Note: Red denotes cautious view at the time of reports. Report titles and dates in bold.Download our reports from Bloomberg: BOCM〈enter〉4
China Market Strategy24 January 2017Focus Chart 6: A review of our calls on HK in 2016.25000HSI240002016/1/21 Weak Hands Marketvolatility continued; wait for abetter entry point230002016/6/13 The GreatChina Bubble:Anniversary Lessonsand OutlookLooming globalvolatility.Turn bullishon Commodities andHK stocks in thesecond half of 2016.2016/9/12 The MostCrowded Trade Looming HKmarket correction. Bondmarket crash is coming.2016/1/25 Stabilizing an UnstableMarket Bearish trend will persist;HSI is likely to make a second low2200021000200002016/6/27 Post Brexit: How to Trade China Longerterm, EU and China have peaked; the RMBdepreciation pressure remains; USD will likelystrengthen; market is going into a technicalrebound, but hard to trade.190002016/4/18 Sweet and Sour HogCycle Rally is now stretched, andrisks are escalating. Commodity willcorrect in the short 1608/201609/201610/201612/2016Source: Bloomberg, ECRI, Bank of Communications (Int’l)Note: Red denotes cautious view at the time of reports. Report titles and dates in bold.Download our reports from Bloomberg: BOCM〈enter〉5
China Market Strategy24 January 2017Recent Reports20120625 The Reflation Paradox20120706 The Declaration of Dependence20120725 The War on Money20120822 Pigs “Run” the Chinese Stock Market20120906 A Monetary Reprieve20120922 A “Fiscal” Reprieve20121019 A “Congressional” Reprieve20121116 Economy at a Crossroad20121204 2013: The Reform Paradox (Preview)20121214 2013: Market at a Crossroad20121219 2013: The Reform Paradox (Full Report)20130117 What’s Wrong with Consensus?20130227 Here is the Thing.20130325 The Market Top: When and Where20130415 Goodbye Yellow Brick Road?20130422 Casino Economics20130513 The Mahjong Investment Theorem20130520 The Mahjong Investment Theorem II: Smallness, Growthiness,Riskiness20130524 A Black Swan Called “Nikkei”20130603 The “Unprecedented” Normal20130610 Auguries of Turbulence20130621 Auguries of Turbulence II (A Hard Rain’s A-Gonna Fall)20130625 Against All Odds : A Tradable Rebound20130722 Small Leap of Forward: Interest Rate Liberalization and Its MarketImplications20130729 National Audit and China’s “Debt Bubble”20130819 Market Oddities20130904 The Most Hated Trades20130910 Running with the Bulls20130914 China and Fed Tapering20131014 Chinese Markets and the US Debt Ceiling Debate20131017 Is the Stock Market Predictable (Ode to Fama and Shiller)20131024 Take Profits20131108 The Plenum: the market is blind in its own muse20131205 Dark Horse and Black Swan (A Preview)20131212 Dark Horse and Black Swan20140127 Lessons from 201320140225 RMB, Property and Significant Market Risks20140304 Risk - “You Know What I mean.”20140311 Risk - Market Bottom: 160020140317 Will RMB Pop the Property Bubble?20140324 Spring Time for Large Caps20140409 Long Yield Holds the Key20140414 3 Pain Trades; Focus on Value20140514 The New Extremes20140617 2H2014: The Sound of Silence20140711 The Sound of Silence: A Volatility Flare20140718 Chinese Soccer, Stocks and a Gigantic Wedge Formation20140723 One Trillion Doubts: PSL, Property and Non-ferrous20140728 One Trillion Hype: Reduce Risk20140805 One What’s Wrong with Consensus20140814 Lending Summersault and Policy Outlook20140822 The Truth about SH-HK Connect and Fund Flow20140827 Market’s Take on Growth and Policy Outlook20140905 Sense and Sensibility: Stop Loss20140915 Monetary and Fiscal Policies on the Cards20140922 Consolidation or Correction - Long Yield Still Holds the Key20140928 Two Diverging TradesDownload our reports from Bloomberg: BOCM〈enter〉20141006 Hong Kong Chasm20141013 The Dollar in Question20141020 A Great Shift in Monetary Policy20141027 Connect Hiccup20141111 Remaining Questions for SH-HK Connect20141117 SH-HK Connect: Breaking New Ground20141119 SH-HK Connect: D.O.A.?20141124 A Rate Cut! And A New Trading Paradigm20141117 SH-HK Connect: Breaking New Ground20141119 SH-HK Connect: D.O.A.?20141124 A Rate Cut! And A New Trading Paradigm20141205 Shanghai Rising: Raising Our Market View20141217 Outlook 2015: Repricing Risks20141224 China: 5 Surprises in 201520150118 Margin Destruction. But is 4200 Possible?20150218 Margin of Danger20150204 RRR Cut, RMB and the Imbalance of Payment20150208 Option D-Day and the Story of Red Temple20150302 Rate Cut and the New Extremes20150320 Price-to-Whatever Ratio: A Bubble Scenario20150330 One-Belt-One-Road and A New World Order20150413 Hang Seng 32,000; Don’t fight China’s Big Mama20150416 A50/500 Index Futures: Pricking the ChiNext Bubble20150420 CSRC, PBOC and the Greed of Man20150506 Taming the People’s Daily Bull20150511 Rate Cut As Expected20150528 “5-30” Once More20150616 The Great China Bubble: Lessons from 800 Years of History20150624 Remembering “2013-6-2520150629 The PBOC cuts. Now what?20150702 The CSRC steps in. Now what?20150706 Shock and Awe20151026 The PBoC cuts. It’s time for a resolution20151109 Re-opening IPO: Devils in Details20151116 A winter of violence20151130 Three Market Extremes20151209 Outlook 2016: The Chinese Curse20151217 The Fed Hikes: Moment of Truth20160104 China’s Circuit Breaker: The First Cut is the Deepest20160108 Circuit Breaker Suspended. Now What?20160115 An Oversold Reprieve20160203 One Last Ditch to Salvage the Property Bubble20160217 Historic Lending! But Three Important Limits20160301 No Growth, No Gain20160307 Two-Sessions in a Cyclical Spring20160321 Unprecedented Divergences20160418 Sweet and Sour Hog Cycle20160503 Ant Financial: A Unicorn’s Defining Moment20160606 The Market Bottom: When and Where20160613 The Great China Bubble: Anniversary Lessons and Outlook20160627 Post Brexit: How to Trade China.20160817 Shenzhen-Hong Kong Connect: A New Era for China’s CapitalMarket and Capital Account20160822 Consolidation20160912 The Most Crowded Trade20161114 A Price Revolution – On Global Asset Allocation20161206 Outlook 2017: High-Wire Act6
China Market Strategy24 January 2017BOCOM InternationalUnit 1701, 17/F, Low Block, Grand Millennium Plaza, 181 Queen’s Road Central, Hong KongMain: 852 2297 9888Fax: 852 2766 3183www.bocomgroup.comRating SystemCompany RatingSector RatingBuy: Expect more than 20% upside in 12 monthsLT Buy: Expect more than 20% upside but longer than 12 monthsNeutral: Expect low volatilitySell: Expect more than 20% downside in 12 monthsOutperform (“OP”): Expect more than 10% upside in 12 monthsMarket perform (“MP”): Expect low volatilityUnderperform (“UP”): Expect more than 10% downside in 12 monthsResearch TeamHead of Research@bocomgroup.comRaymond CHENG, CFA, CPA, CA(852) 3766 1818raymond.chengBanks/ Non-Bank Financials(86) 10 8800 9788 - 8058lishanshanLi WAN, CFA, FRM(86) 10 8800 9788 - 8051wanliHannah HAN(852) 3766 1858hannah.hanJennifer ZHANG(852) 3766 1850yufan.zhangConsumer(852) 3766 1808summer.wangOliver LIU(852) 3766 1835oliver.liuEnvironmental Serviceshao.hongKaren TAN(852) 3766 1825karen.tanGrace HUA, CFA(852) 3766 1837Grace.huaAlfred LAU, CFA, FRM(852) 3766 1807alfred.lauPhilip TSE, CFA, FRM(852) 3766 1815philip.tseCarmen WONG(852) 3766 1830carmen.wong(86) 21 6065 3606louis.sun(852) 3766 1803christopher.yimGeoffrey CHENG, CFA(852) 3766 1809geoffrey.chengFay ZHOU(852) 3766 1816fay.zhou(852) 3766 1805angus.chanRenewable Energy(852) 3766 1810wallace.chengGaming & LeisureLouis SUNTechnology(852) 3766 1807alfred.lau(852) 3766 1811david.liHealthcareDavid LI@bocomgroup.com(852) 3766 1802PropertySummer WANG, CFAAlfred LAU, CFA, FRMHao HONG, CFAStrategyShanshan LI, CFAWallace CHENGHead of Research/ StrategyChris YIMTransportation & IndustrialsInternetAutomobile & DefenseYuan MA, PhD(86) 10 8800 9788 - 8039yuan.maConnie GU, CPA(86) 10 8800 9788 - 8045connieguMengqi SUN(86) 10 8800 9788 - 8048mengqi.sunDownload our reports from Bloomberg: BOCM〈enter〉Angus CHAN7
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China Market Strategy 24 January 2017 Download our reports from Bloomberg: BOCM〈enter〉 4 A review of our calls in 2016: We estimated that the trading range for the Shanghai Composite in 2016 was between 2500 and 3300 ("Outlook 2016: the Chinese Curse" December 9, 2015).In January 2016, the Composite plunged to 2600 after the circuit
