China Stocks Rally Coming, but When?

Gene Linn |

With stocks in Hong Kong and Shanghai hitting year-lows last Friday and easily slicing through one resistance level after another, the question emerges: “When does the bleeding stop?"

Soon, according to Core Pacific Yamaichi, which expects a short-term rebound. Technical factors will fuel a bounce, the brokerage said Monday. It notes the Relative Strength Index for Hong Kong has dropped to the oversold level. However, Core Pacific Yamaichi thinks any rally will stall at about 22,600, a modest increase of less than 3%.

A lasting, substantial rally depends largely on Chinese inflation and economic developments. Overseas factors like Euro debt and the fate of the U.S. economic recovery are important, but in the long run Chinese news is fundamental.

There are some widely held views on Chinese inflation and economic developments:

  1. Inflation will peak soon, perhaps this month. China will stop tightening its economy some time after inflation begins to decline. An easing of inflation and of economic controls will lead to a major rally as investors rush to buy undervalued China stocks.

I agree with all of these points, but one big question is when will China actually ease up on its interest rate increases and rises in banks’ reserve ratios? Haitong Securities predicted last week that won’t be until Chinese consumers stop feeling the bite of inflation. Significant monetary easing may not happen until inflation falls to 4%, Haitong said. Given that inflation is expected to hit 6% this month, 4% may be a ways off. I think Haitong’s prediction makes sense.

Another big factor is whether investors will wait until they see a relaxation of tight money policies or anticipate it. The “anticipation” school thinks investors may jump in within weeks. They think the next interest rate hike may be seen as the last one, giving investors the green light.

The nature of the market is to anticipate events. And with a major rally almost universally expected, big money is primed to come in. But my humble and fallible opinion is the most likely outcome is that investors will conclude the next rate increase may not be the last and will wait for a significant reduction in inflation before anticipating an easing of China’s tight grip on its money supply.

Probably the rate won’t have to go down to 4%, but a significant decline won’t come until at least August, when July inflation is announced, or maybe a month or two later.

A note of caution: Trying to predict Chinese stocks movements is tough, maybe even foolish. My point is investors should consider the possibility a rally may not start until late summer or early fall. End

DAILY FIX – Lower in Light Trading

Hong Kong Blue Chips: -96, -0.4%, to 21,600, 06-20-11, Hang Seng Index

Chinese Stocks in Hong Kong: -36 -0.3% to 12,009, 06-20-11, HSCE Index

Shanghai Stocks: -0.8%, 2,621, 06-20-11, Shanghai Composite Index.

Chinese Stocks in the U.S.: -2.2 to 409.7, 06-17-11, Bank of New York Mellon, ADR Index-China

Insight: Hong Kong opened higher following Wall Street gains Friday, but slumped in light trading to post a small loss. KGI Research

Quotable: "Looking ahead, given the weak market sentiment and the likelihood for the Chinese government to have another round of rate hike soon, we see the HSI to continue its weak trend and test its nearest support level of 21,000 mark in the near term." BEA Securities. 6-18-2011

Chinese Company to Watch: "China Oversea (0688:HK), property development and investment. Technical support on HK$15 (Friday's close) is very strong as (moving averages) cross together; valuation at this level is relative(ly) attractive." Core Pacific Yamaichi. 6-20-2011

Brokerages and analysts cited have disclaimers on their websites emphasizing their statements are for information only. They do not endorse my blog, and I don't endorse them.

For a list of Chinese companies sold in the U.S. and information on each company go to http://www.adrbnymellon.com/dr_country_profile.jsp?country=CN

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
CATO Cato Corporation (The) Class A 33.00 0.10 0.30 32,408

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