Chinese Stock Accounts Empty Before Rally on 'Capitulation'
Comment of the Day

December 05 2012

Commentary by David Fuller

Chinese Stock Accounts Empty Before Rally on 'Capitulation'

This informative article from Bloomberg describes conditions in China's stock market just before today's surge. Here is the opening:
Chinese stock investors emptied trading accounts at the fastest pace in 16 months last week, three days before the benchmark Shanghai Composite Index (SHCOMP) rallied the most in three months.

The number of Chinese stock accounts containing funds dropped by 205,000 to 55.6 million, the largest decline since the week ended July 8, 2011, according to regulatory data compiled by Bloomberg. The number of funded accounts slid to the lowest level since the week through Nov. 26, 2010, after reaching a high of 57.28 million in June 2011. About 112 million accounts are empty or frozen, the data show.

Investors may have reached the point of "capitulation," a buy signal for contrarian investors, Oversea-Chinese Banking Corp.'s Vasu Menon said. The Shanghai Composite will rally 48 percent within nine months after its decline below 1,960 signaled selling has peaked, according to Tom DeMark, the creator of indicators that aim to show turning points in securities. The Shanghai gauge climbed 3 percent to 2,034.58 at the 11.30 a.m. local-time break.

"The best time to buy in certain markets is when there's a very high level of skepticism," Menon, who's vice president of wealth management at Oversea-Chinese Banking, said from Singapore by phone today. "People are very skeptical about the market because it has underperformed for such a long period of time and people have become despondent."

The Shanghai Composite closed below 2,000 for the first time since 2009 on Nov. 27 amid concern a seven-quarter economic slowdown may drag on earnings and a possible wave of new share sales would draw funds from existing equities. The index fell to 1,959.77 on Dec. 3.

David Fuller's view China's Shanghai A-Share Index has been in an overall downward trend since August 2009. Up until that point a strong recovery rally was underway until Chinese policymakers began cutting off their considerable monetary stimulus, due to fears that they were creating another property bubble.

They were, as money had fled to property and it has taken over three years for monetary officials to rein in many of the excesses. Property prices have remained generally strong in tier-1 cities, according to Eoin who visits the country regularly. However, they have fallen considerably in provincial areas. I have even heard reports of speculative buyers fleeing their overpriced homes - shades of the West.

Arguably, property speculation has been curbed sufficiently and it makes more sense for China to stimulate its stock market. Interestingly, today's big rally in shares came after the new government's first meeting, led by the reassuringly powerful and apparently relaxed new leader, Xi Jinping. That is the way events often unfold in China.

With a new government in charge and widespread bearishness towards China, which still has a GDP growth rate that most countries can only envy, this is now a favourable background for contrarian / value investors.

Identifying bear market lows can be a hazardous business until we see some clear evidence that demand is returning. My last review of China on Thursday 29th November concluded with the following:

I take some comfort from the Hong Kong HSI's performance, which cannot be entirely explained by the currency link to the USD. Also, the HSCEI, quoted in HKD, shows evidence of base formation development. Nevertheless, I will remain nervous about China's A-Shares Index above, at least until it surges above the upside key day reversal seen 7 days ago, and hopefully not too long thereafter largely confirms a trend reversal by also taking out the early November high.

So what can we now say about China's Shanghai A-Shares' technical action shown on a daily basis, plus an update on the performance of some other important Chinese indices?

Today's explosive rally closed near the key day reversal high on 21st November, which you can also see on the chart above. We will probably see some additional upside follow through this week, and if so, that should confirm an end to the bear market for this mainland Index. A move back above recent highs near 2240 would entice more new buyers. If a bull trend of consequence is beginning, as Eoin and I believe, some of the recent capitulation sellers should be re-entering on future setbacks, helping to create a new uptrend defined by higher reaction lows. That would keep the cheerful Xi Jinping smiling.

This second article from Bloomberg is also revealing: China's Stocks Rise Most in Three Months, Machinery Makers Surge - Note the graphic at the beginning comparing the performance of Shanghai A-Shares and the Hong Kong Hang Seng Index.

The big, important difference between the Shanghai A-Shares Index and other China indices is that it is heavily weighted by Banks, Materials and Property companies. Therefore, it cannot really improve without these sectors performing.

Here is the opening from the article immediately above:

China's stocks rose the most in three months after the government allowed insurers to invest more in banks and investors speculated profits at construction and cement companies will increase.

Sany Heavy Industry Co. (600031) jumped 10 percent andAnhui Conch Cement Co. (600585) climbed to a six-month high as analysts said the first meeting by the ruling party under new leader Xi Jinping signaled increased urban development.Industrial Bank Co. (601166) led a gauge of financial stocks to the biggest gain in two months as a regulation limiting investment in banks by insurers was abolished. Ping An Insurance (Group) Co. of China Ltd. jumped 4.1 percent as HSBC Holdings Plc agreed to sell its stake.

The Shanghai Composite Index (SHCOMP) surged 2.9 percent to 2,031.91 at the close, capping the biggest advance since Sept. 7. Trading volumes were 102 percent above the 30-day average, according to data compiled by Bloomberg. The CSI 300 Index rose 3.6 percent to 2,207.88, with the materials, industrial and financial gauges climbing at least 3.6 percent.

"Lately, the government had been relaying messages about improving the economy, in particular its plans for urbanization," said Mao Sheng, an analyst for Huaxi Securities Co. in Chengdu. Investors "see a clearer direction and roadmap for government reforms," Mao said.

If China Shanghai A-Shares Index continues to recover from here, as I suspect, in line with the government's plans mentioned in this article, its performance over the next two to three years could double or more from the recent low. This forecast assumes strong earnings growth so that the current PER of 11.21 far from doubles and the current Yield of 2.81% does not halve.

Meanwhile, Hong Kong's Hang Seng Index (PER 11.39, Y 3.19%) may be completing its recent consolidation near the February high and the HSCEI (PER 8.90, Y 3.51% remains steady in base development. Both are flattered somewhat by being quoted in HKD, which remains pegged to the USD. The CNY, in which SHASHR is quoted, remains considerably stronger.

Lastly, I maintain that industrial miners will see an improvement in performance as China's GDP improves.

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