OCM’s Stather-Lodge: China’s new normal, but is a bubble forming?

Jason Stather-Lodge

While the leaders of the IMF may be busy sorting out the mess in Athens, the main story is how the Chinese authorities continue to push for their own currency, the renminbi, to become a reserve currency.

The list, which to date encompasses the US Dollar, the Euro, the Japanese Yen and UK’s Sterling, is expected to include the Chinese currency, within the next 12 months as the authorities are moving quite rapidly now to complete the last items necessary to free capital account flows. 

The inclusion of the renminbi, or Yuan (to give it it’s formal name), would be another key step in China’s global role. The latest step in capital account opening started last week as Chinese regulators opened up the sale of both equity and bonds to the tune of $48bn, starting on July 1st. Given the new trading lines between Shanghai and Hong Kong, this should open up capital markets even more. 

All these reforms will no doubt put more money into the financial system, but in turn may redirect some of the money flow even more. Further out we may see companies such as HSBC relocate its headquarters to Hong Kong to gain access to these changes and we would also question the long-term viability of the Hong Kong Dollar, should the renminbi make the IMF list.  

With more money expected to enter the system as capital markets open up, more attention will be on China and its economy. Looking at the headlines, where the local CSI 300 index is up 37 per cent year-to-date and the Shanghai composite index up 43 per cent year-to-date, we would want to investigate the economic and corporate data more closely. 

The aim of that review is to prove of disprove that this significant market move is related to fundamentals or whether a bubble could be forming (which it appears to be) fuelled by deregulation in the market. China has seen significant increases in the number of less sophisticated investors as private share dealing accounts have soared on the back of margin (i.e. the ability to borrow against stock).

If we look at the Shanghai Composite Index, it is now trading at 62 times reported earnings as opposed to the S&P500, for example, which trades at 18 times and the FTSE 100 that trades at 17 times. To give you an example of how this relates in practical terms, Hanergy, a Chinese solar business, came to the market the other week at a valuation that was seven times larger than the biggest US solar company. 

While official Chinese data shows that growth is slowing, but heading towards a soft landing, indicators such as electrical consumption (usually a solid indicator of industrial production) have shown a sharp slowdown. Against this, the People’s Bank of China have kept interest rates low as people rely on the central state to keep the trucks rolling. However, with China’s state banks dominating the world’s largest list (four of the top seven banks in the world are Chinese) it seems that It would be very hard to stand in the way of such financial fire power. 

Jason Stather-Lodge, CEO of OCM Wealth Management