Despite recent falls, Chinese domestic equities still look overvalued and a cautious approach is warranted says William Ballard.

July 2015

Key points

  • China’s equity market has crashed
  • The authorities have taken drastic action to arrest the decline
  • We see the long-term potential
  • China has to offer
  • But valuations of domestic equities remain excessive
  • Chinese companies listed in Hong
  • Kong are more attractively valued

After an unprecedented run over the past two years, China’s domestic equity market has suffered a dramatic correction. Since its peak on 12 June, the Shanghai Composite Index has fallen nearly 30 per cent. The authorities have taken drastic action to stem the slide in share prices by introducing a plethora of emergency measures. The relaxation of lending rules, to make it easier for investors to borrow to invest in shares, the restriction of IPOs and short selling are some of the more conventional measures adopted. The more extreme measures that have temporarily halted the market rout have surprised even seasoned international investors. Domestic investors with stakes in excess of five per cent in any one company have been blocked from selling their stakes for the next six months. Since the start of this week, around 1,300 companies have voluntarily suspended trading in their own shares.

Long-term impact of intervention unclear

China is in the midst of a period of transformational change as it moves to rebalance its economy to a path of longer-term structural stability. The opportunities offered for investors within this huge and changing market should not be underestimated, but neither should the risks. The unprecedented level of intervention has shown initial signs of stabilising the domestic equity market. The question now is whether there will be a longer-term impact.

Mindful of valuation discrepancies

The emerging-market equity funds which I manage all have a substantial, long standing underweight position in China. As long-term investors, we can see potential. However we are mindful of the disconnect between the bubble-like valuations of some domestic equities and the more attractive valuations found in Chinese companies listed in Hong Kong or offshore. Furthermore, we are aware of the headwinds companies face from the continued slowing of the domestic economy.