Friday, 25 April 2008

Macro-Level Trends – Chinese SSE Stocks – The Economic (Olympic) Flame Returns

It’s the starting gun that switches potential energy to kinetic, a demonstration of which will be seen in Beijing, Shanghai, Shenzhen in the months to come. But in China’s economic race, after a 6 month hesitation, the authorities have clearly pulled the trigger via a sharp turnabout in regulatory reform to set investors off.

As the financial press have well documented, Thursday’s (24.04.08) massive 66% reduction in equities’ stamp-duty (from 0.3% to 0.1% of tradable value) proved the ‘fiscal injection’ that a 6-month slipping market needed to surge; up 9.3% on the day. Less than a year previously, in May 07, the Chinese political and regulatory mandarins endeavoured to cool the apparent never-ending bull-market with the 66% trebling of payable taxation. After a 5 month lag that hurdle and ‘topping-out’ rumours finally brought the market slowdown and reversal.

But were Thursday’s events such a surprise; surely not? As the world’s glare stares ever more intently at all aspects of China, the authorities were always going to steer the capital markets in the run-up to the games to demonstrate the country’s ongoing fiscal strength, re-enforce the booming China story, provide global financial credibility to Chinese Banking brands and critically open the world’s eye’s to the ‘invest-ability’ of the nation. Investment through FDI, extended JV networks, a foreign push to access Shanghai and Shenzhen bourses or indeed have high-net worth individuals push their investment managers seek a way in via PE interests.

Critics, such as today’s FT editorial, highlight that such obvious direct and influential governmental action makes a mockery of what are supposed to ideally be balanced, efficient market dynamics, investors reacting irrationally to external influential drivers as opposed to sound valuation methods based on good fundamental analysis. But ironically, unlike the ripple-effect of rumours and hearsay that can drive acquisitions and disposals, the previous night’s TV broadcast informing of the duty reversion could be said to be the theoretical fundamentals of EMH, so the massive SSE index jump only reflective of previously pent-up demand. The theorists will discuss for months to come, but the reality is, as any analyst knew, that the Chinese leopard was not about to change its interventionist spots, especially so at this juncture. It was only ever a question of exactly when and by how much.

The primer had come on Tuesday when the subtler action of slowing the market absorption of non-tradable stock (of mostly state asset companies) reduced the previous dilutive effect of certain stock-holders that had been taking place. That pricked-up the markets ears to the possibility of further ‘assistance’, especially since the avg p/e measure fell from near 50 in Oct 07 to ‘only’ 22 recently. Given the Chinese bias to traditional primary, processing and heavy industries, even that is more than double the value of similar western related indices with similar characteristics. Ford has just hit a 2010 p/e of 10, and that’s seen as optimistic against GM’s 5, so even now after the 6 month relaxation period, many will say a p/e of 22 is over-optimistic…but who is really to say when the NYSE and SSE operate in such vastly different economic, corporate, institutional and of course governmental contexts?

The true paradox is that the Chinese population has been switched-onto and into a level of Capitalism over a period of 5 or so years, when it took the USA over 100 years to reach the same per capita figures. Of course, aswell as the stock-market rebound, China has slowly been letting the value of the Renminbi rise against the US Dollar, both at America’s bequest but also for its own purposes as hopefully hordes of foreign tourists visit over the summer. The Rmb7 : $1 rate, and perception of the FX value to foreigners, will hopefully in turn drive up the volume of inbound foreign/US$ liquidity, so adding yet more to the foreign reserve account, and it is undoubtedly hoped partially slow the ongoing Dollar drop.

Back to stocks, and beyond highlighting the artificiality of China’s exchanges, Charles Dumas at Lombard Street Research, was quoted on 24th as saying “China is entering an unpleasant quadrant of the economic cycle where it has to cut back growth to stop inflation accelerating." Chinese officials have undoubtedly been keeping eagle-like eyes on US and UK press, and the Telegraph report of the same day hinted at the possibility of a rapid Chinese sell-off by those private investors lured in at the top-end of the 07 rise. Such reports may well have been the catalyst to settle and re-energise the local markets.

Given the ‘serendipity’ of the Beijing Auto Show this week, and so a heightened public and investor awareness in domestic autos, aswell as upbeat Q1 results from western VMs like Ford and VW what does the sudden Chinese stock hike mean for publicly listed automotive enterprises? investment-auto-motives will be taking a close look soon, but quite obviously the general upturn will give reason for auto CEOs to smile after what has been a rather tortuous ride. General market confidence will buoy MarketCap values and if that confidence can reign up to and beyond the Games, economic growth could even exceed the ‘slowed’ 9.5% of GDP rate, or at worst maintain that level. This in turn keeps commercial and consumer confidence high, even if the pushed-for pay increases don’t emerge as the labour-force hopes, so keeping the spending wheel spinning.

Those boosted MarketCap values greatly enable listed company CEOs to obtain even greater gearing from domestic and possibly part-foreign lenders, giving them the ability to implement what could be sector changing grand plans, probably endeavouring to appease government who’ve been pushing for consolidation for some time. Conversely, the booming economy drives more and more models to be introduced from ‘old state’, foreign JV and a whole crop of emergent new Chinese; some still to enter. The reported increase in available car models from 200 in 2007 to over 250 by end 2008 says much, but can such an influx really be viable given that even now margins on even newish vehicles are being slashed to sell. Probably not, as we’ve said before, there’s massive scope for consolidation on model-line, regional or value-chain rationale.

All CEOs, but perhaps those of Listed companies more so, will undoubtedly be looking for best-fit options as part of their M&A strategies, and they probably feel, like us, that now is the time to start trying to put those deals in place before the unknown economic after-effects of the Olympic Games come into being.

There’ll be a lot of schmoosing and a lot of corporate-sports analogies banded around in corporate hospitality boxes and local hotel dining rooms. Just as the Chinese athletes will be focusing on their future performance, so too will the auto-industry executives, hoping refreshed equities market excitement can be exploited to raise additional funds, whether fixed-income loans based on MarketCap, new SSE rights issues or even the confidence to list upon HKSE (next to Brilliance Corp) or even the NYSE or LSE to gain that all important foreign interest as the world looks on at this national highpoint.

And although it's been the car-makers who've had the spot-light, given the massive array of auto-maker clients (yet set for consolidation), it could well be the Tier 1 suppliers that take the baton and lead the pack.