Reported by Alexander Kalis, Managing Partner | Portfolio Manager & Head of Manager Research, Milltrust International
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In the past, the trigger points for a market crisis have been the banks. In the case of China, although we can be concerned about increasing NPLs, the banks are not too highly leveraged when looking at their loan to deposit ratios (<70% vs 150% in US and 200% in Europe). The banks are also 100% State-Owned so the possibility of a bank failure would be very remote. It is true that the government’s balance sheet total liability of GDP is close to 200%, however, Fang argues that there is a significant difference in the composition of the balance sheet vs the US and Japan for example, as the Central government of China actually owns assets, owning the land and the SOE itself. As a result, they can afford to have higher debt levels. In addition, most of this debt is internal debt rather than external debt. Therefore Fang is confident that a crisis is only a remote possibility. This does not preclude 1 or 2 local government debt issues becoming a problem which would impact investor sentiment negatively.

 

Currency
Keywise expects further gradual depreciation of the RMB vs the USD and claim that the currency has 10-15% more to go in order to be at fair value and compete with neighbouring countries like Japan and Korea which have already devalued their currencies significantly in 2014. China would essentially give back all the currency gains made in the last 5 years. A one-off devaluation would be a healthier and preferred approach and would get investors ready to look at the market once again.

 

Market Attractiveness
The market just experienced a -1.5 standard deviation event and is at a good entry level for long term investors. From a historical and relative point of view, markets are cheap, in particular shares of companies listed in Hong Kong (8x P/E).
In addition, China is entering into  a lower interest rate environment and interest rate bearing products will no longer be as attractive as equity markets. This could eventually lead equity markets to re-rate on the upside. If we have a one-off devaluation of the currency, we will see foreign investors returning to the markets. However today Keywise anticipates that the A share market will continue to experience downside pressure whereas in Hong Kong it is a good time for those with a long term investment outlook to pick up the high quality names.