Worth a look.
What's happened?
China A and H corrected 7% and 3% on the first day of trading in 2016, the worst start of a new calendar year in the history of the Chinese equity markets. The 7% drop in CSI300 triggered the new circuit breaker mechanism which was implemented for the first day today. CNY fixing and CNH also weakened 0.15% and 0.95% vs. the USD on Jan 4 (to 6.50 and 6.63 respectively), extending the 5.77% and 5.36% depreciation in 2015.
What triggered the selloff?
The commonly cited explanations for the selloffs include: 1) a marginally weaker than expected Caixin PMI for December, which came in at 49.7 vs. Bloomberg consensus of 49.8, below 50 for the 10th consecutive month; 2) market concerns over near-term liquidity conditions, notably the expiry of selling ban (on Jan 8) from major shareholders, the resumption of IPOs, and the confirmation of IPO reform in A shares; 3) the continuing weakness of the CNY/CNH and the related concerns regarding capital (out)flows, domestic monetary tightening, and corporate earnings; and 4) concerns about policy stimulus inaction (or lower intensity) as the government begins to emphasize supply-side reforms.
10FAQs about Chinese equity markets at the start of a new year.
1. How does the new circuit breaker(CB) work in A shares? Exhibit 1 summarizes the key features of the CB in A shares and how it compares with CBs in major markets globally. Simply put, the whole market will suspend trading for 15mins when the CSI300 index moves +/- 5% from the previous day's close, and will halt trading for the whole day when the index moves +/-7%. It is noteworthy that the 10% price limits remain valid at the stock level and the new rules only apply to the CSI300 index (that's why ChiNext was down 8.2% today). We reiterate our view that the new CB doesn't fundamentally change the volatility profile of the A-share market as it is inherently driven by the investor mix (dominated by retail investors) and their investment philosophy (strong growth/momentum bias vs. value). The lower price limits of the new CB also suggest that today's price actions may not reflect a market clearing price, as history shows the A-share market only managed to rebound 0.9% on average on the subsequent day post the previous 13 large, one-day corrections over the past decade.
Exhibit 1: How does the new circuit breaker mechanism work in A shares? And how did market fare historically after a significant 1-day drop?
Sources: Bloomberg, SSE SEC, NYSE, NASDAQ, IIROC, SEBI, NSE, BSE, JPX, KRX, Bursa, SGX, TWSE, SET.
2. How muchcould major shareholders be selling? As a background, on July 8, the CSRC banned company shareholders with stakes of more than 5% from selling for the next 6 months as a part of the regulator’s effort to provide an external stabilizer (reduce supply) to smooth out volatility during the sharp market correction in July 2015. These bans will expire on Jan 8 and we estimate that major individual shareholders with over Rmb1.1tn of stock holdings, representing 5.8% of total A-share free-float market cap, could be incentivized to sell given the 13% market rally since July 8, although the actual selling could be considerably smaller. On Jan 4 after market close, according to SINA.com, there were news reports suggesting that major shareholders won’t be able to sell even after Jan 8 subject to further clarifications from the CSRC. If these reports prove to be true, we think they may help alleviate liquidity concerns in the short term, but they would not change our core view that the A-share market will face several market liquidity headwinds in 1Q/1H16. See China Strategy: 2016 Outlook: A nuanced story; alpha markets, Dec 3.
Exhibit 2: We estimate that major individual shareholders with over Rmb1.1tn of stock holdings could be incentivized to sell post the expiry of the selling bans
Source: Wind.
3. What's thepotential market impact of the resumption of IPOs? On November 6, the CSRC reactivated the IPO window after freezing it since early July. So far, 28 companies have listed on the main, SME, and ChiNext boards, raising Rmb11bn (US$1.7bn) in total. According to the CSRC, 600+ companies are currently in the pipeline, although we believe the regulators will carefully manage the pipeline according to market conditions to avoid unnecessary liquidity squeeze/shocks. From a tactical standpoint, history suggests the A-share market tends to trade sideways to slightly down shortly after resumptions became effective but it doesn't seem to fully explain the selloff today, at least in that magnitude. We think investors may be more concerned about the confirmation from the State Council/NPC of IPO reform (from approval-based to registration-based), which will start on March 1, but implementation details are not yet available. As detailed in our 2016 China A-share outlook report, we estimated that around Rmb1.2 tn of A-share equity financing may come to the market this year, representing a 20% increase from 2015, 2.9% of A-share free-float market cap, but still lower than the historical average of 5.5% during 2000-2015.
Exhibit 3: History suggests that resumption of IPOs has had only short-lived impact on the market, and next year's total equity financing is likely below historical average, based on our estimate
Source: Bloomberg, FactSet, Wind, Xinhua News, Goldman Sachs Global Investment Research.
4. What'sa down day in the 1st trading day mean for the rest of the year? While we don't form our views based on technical indicators and episodic analysis, the selloff in the first calendar year's trading day has sparked questions on what a poor start could mean for full-year returns. Empirical evidence suggests that a down day on the first trading day in a calendar year is usually followed by a tough trading environment for the rest of the year, with the offshore markets registering 80%, 100%, and 60% probability to return negatively in the ensuing 1, 3, and 12 months respectively.
Exhibit 4: A down day on the first trading day in a calendar year tends to suggest a tough trading environment for the rest of the year
Source: FactSet, MSCI, Wind, Goldman Sachs Global Investment Research.
5.What are the key policy changes and announcements that have been made in the past 1 month? And what are the key events ahead? The international and domestic event calendar was very active when investors were away for holidays in December. Externally, the ECB announced to extend its QE program in early Dec and followed by the 25bps policy rate hike by the Fed, the first hike since 2005. In China, the Central Economic Working Conference (CEWC) was held on Dec 21 after which the concept of 'supply side' reform was prominently highlighted. The Rmb was admitted to the SDR basket on Nov 30 but the CNY/CNH has lost 1.6%/3.1% since then, which partly prompted the authorities to tighten restrictions on capital flows. In the equity market, 14 ADRs were added to the MSCI universe on Dec 1, the NPC approved the long-awaited IPO reform in late Dec after the CSRC re-opened the IPO window in Nov. At the company level, PetroChina and China Merchants Group/Sinotrans announced their respective SOE reform plans in late Dec, while China Vanke filed for suspension due to pending corporate action.
Looking ahead, we expect 2016 to be another eventful year as it will be the maiden year of the implementation of the 13th Five Year Plan, and SZ-HK Connect will likely be announced and implemented in 1H16, followed by the discussion of A shares potentially going into MSCI benchmarks. Additionally, market liquidity events (such as the 'exit' from the National team), and the development regarding the anticorruption campaign could have far-reaching macro and investment/trading implications, in our view.
Exhibit 5: Quite a number of important policy changes have been made last month, and we expect the policy/event calendar to stay active in 2016
Source: Bloomberg, Reuters, Xinhua news, PBOC, Goldman Sachs Global Investment Research.
6.What are our key views on the core macro drivers (growth, liquidity, reforms)?
Our economists forecast China's GDP to grow 6.4% in 2016 (from 6.9% in 2015), with a tough 1Q in terms of sequential growth momentum (5.8%). The growth orientation is clearly changing (more services, less FAI and exports) but we believe the skepticism around the ‘true’ growth state of China, and the associated leverage/bad debt concerns, will remain elevated as our alternative growth measure suggests that China’s growth may be 1-2pp weaker than official GDP statistics may indicate.
Domestic policy/liquidity is likely to stay easy to support growth and to facilitate reforms—we expect monetary and fiscal policies to further loosen. However, the Fed's policy normalization cycle, and the risks regarding a significant Rmb depreciation, have weakened the macro liquidity arguments somewhat.
Reform should remain a topical issue in China as 2016 is the maiden year of the 13th FYP. While we may see acceleration of reform implementation in areas including SOE and capital markets, we think the bar for reforms to single-handedly re-rate Chinese equities is much higher than before given the policy surprises investors witnessed (and hence the questions on policy efficacy) in the equity and FX markets last year. Additionally, we also expect more corporate (SOE) defaults to surface, which could sporadically provoke systemic concerns and market volatility.
Exhibit 6: We expect macro growth to decelerate, policy to stay easy, and more corporate defaults in 2016
Source: Bloomberg, CEIC, Wind, Goldman Sachs Global Investment Research.
7.How do we position China in a regional context to start 2016? In our 2016 outlook published on Dec 3, we lowered China (MSCI China) to Marketweight from Overweight on slowing sequential macro growth and A-share liquidity risks in 1Q as discussed above. Specifically, we forecast only mid-single-digit EPS growth for H and A shares in 2016, but limited room for multiple expansion as valuations appear fair benchmarking against our macro forecasts, with both MXCN and CSI300 trading at mid-cycle valuations. While our end-16 index targets currently imply 13% and 15% price return for MXCN and CSI300 after the two indexes have fallen 4% and 3% since Dec 15 (vs. 6% for MXAPJ), our envisaged short-term macro and liquidity headwinds lead us to believe that it's too early to turn aggressive on Chinese equities. Also see Asia Pacific Strategy: 2016 Outlook: Muted returns, targeted opportunities, Dec 3.
Exhibit 7: In our 2016 outlook report, we lowered China to MW on slowing growth and A-share liquidity risks in 1Q
Source: FactSet, CEIC, Goldman Sachs Global Investment Research.
8. Sector allocation? Top- and bottom-3 performing sectors have yielded 37% long-short returns in 2015 on significant rotations, meaning that investors need to embrace a nimble investment approach to seek alpha. We are Overweight Tech, Telecom, Healthcare, and Property to start the year, reflecting our ‘New China’ bias and defensive orientation.
Exhibit 8: We are OW Tech, Telecoms, Healthcare, and Property to start the year to reflect our 'New China' bias and defensive orientation
Source: FactSet, Bloomberg, MSCI, I/B/E/S, Goldman Sachs Global Investment Research.
9. Themes? Growth scarcity, risk/reward, and Rmb risks are the key axes in our thematic thinking. We would build core positions around ‘New China’ stocks, which managed to grow top-/bottom-line by 37%/45% in 1H15, with ADRs currently being our top idea in that space given the MSCI inclusion catalyst. In ‘Old China’, select SOE reform beneficiaries and ‘bottomed out’ old economy stocks, notably telcos and energy-related companies, look attractive given where they are traded in terms of valuations and profitability expectations. To hedge the Rmb deval risks in the equity space, we like fundamentally sound companies which may benefit when the Rmb weakens, paired against those which may lose out.
Exhibit 9: Key themes: ‘New’ vs ‘Old’ China; 'Old China' revengers; Rmb hedges
Source: Bloomberg, FactSet, Wind, Goldman Sachs Global Investment Research.
10. What's the key concern that most investors are concerned about?CNY. The topic of Rmb devaluation risks came up in virtually all of our investor meetings in December. To express our view that there could be non-trivial risks for a one-off Rmb devaluation and to position for the potential market ramifications, besides options strategy, we highlight a group of stocks which may fundamentally benefit in a Rmb depreciation scenario based on our analysts’ bottom-up estimates. In a similar vein, we have put together a list of companies which may lose out when the currency weakens. In fundamental terms, every 10% Rmb depreciation (vs. the USD) could on average boost/reduce 2015 earnings by 41%/81% for the beneficiaries/losers group, respectively.
Exhibit 10: These stocks may disproportionately benefit or lose out in a Rmb weakening environment, based on our analysts’ estimates
Source: FactSet, I/B/E/S, Gao Hua Investment Research, Goldman Sachs Global Investment Research.
