The bull is in the China shop as stocks continue rally

The Year of the Ox starts next month, but bulls are already leading Chinese stock markets higher.

The benchmark Shanghai Composite Index has gained about 3 percent since January 1, after surging 14 percent last year and ending at a near three-year closing high.

That’s welcome news for investors who have worried about their portfolios during months of pandemic and economic sluggishness.

In the past week, the Shanghai Composite hit its highest point since December 2015, and the National Bureau of Statistics announced that the Chinese economy expanded 6.5 percent in the fourth quarter, exceeding analysts’ forecasts.

But is this all too good to be true?

The higher stock prices climb, the more some individual investors are feeling a sense of unease that the bull market might be about to turn tail.

“I invested a small sum in A shares about seven months ago, and they rose over 20 percent in a short time,” said a 26-year-old surnamed Zhu, who just finished her postgraduate study in the US and is a newcomer to the stock market in China.

“I’m worried, however, that the A shares are about to hit a cap and then drop back down,” she said. “I’m watching the market closely these days and will sell the shares if there are signs of pullback."

A 47-year-old manager surnamed Wang, who works for a foreign company in Shanghai, said he is concerned about the strength of the stock market nowadays and is more likely to invest his money in the real estate market this year.

Still, market analysts remain upbeat about good prospects for Class A shares for the rest of the year.

"Due to attractive valuations and the continued inflow of foreign capital, we believe that A-shares still have a chance to outperform average global market earnings in 2021," said Zhou Wenqun, head of equity investment in Fidelity International China.

The drivers in share prices over the past two years have been technology, media, telecoms, consumer goods and health care. Zhou said they are likely to continue to lead the way as the economy recovers from the coronavirus pandemic.

"Demand appears to be stronger than supply in the short term,” he noted. “The rally in optional consumption can lead to more investment opportunities, and leading Chinese companies have been showing their strength since the pandemic. Some of them are going overseas and expected to become global enterprises.

However, every market has its risks. Zhou cited a few for Chinese investors — slower-than-expected distribution of COVID-19 vaccines around the world and a widening gap between rich and poor.

Byron Wien, vice chairman of Private Wealth Solutions, and Joe Zidle, chief investment strategist, recently published their list of the “10 Surprises of 2021.” It included the expectation that China A-shares would lead emerging markets higher.

Byron defines “surprise” as events that the average investor might give only one-in-three odds to happen, while he views them at a 50 percent likelihood.

"Despite the hostile rhetoric from both sides during the US presidential campaign, President-elect Biden will begin to restore a constructive diplomatic and trade relationship with China," the two men wrote.

Another boost to the A-share market is a regulatory relaxation on domestic investments by so-called Qualified Foreign Institutional Investors (QFII). That means, in essence, that foreign investors certified by Chinese securities regulators can invest more in Class A shares.

On December 29, the first day the relaxed rules came into effect, there was increased activity by foreign investors.

"Demand from global investors for China's A-shares continues to grow at a very fast pace," said Tim Wannenmacher, head of Asia-Pacific financing at UBS, the first international institution to be approved as a qualified foreign investor in yuan-denominated A-shares in 2003.

Tommie Fang, head of China global markets at UBS, said the relaxation of the QFII rules, the launch of the Shanghai/Shenzhen-Hong Kong Stock Connect system and the inclusion of A-shares in three major global indices bodes will encourage more foreign money to flow into the China market.

“It is important because foreign participation in China’s onshore securities lending and borrowing enhances the 'price-discovery' function of the stock markets,” Fang said.

Standard Chartered Bank China, which serves as a custodian bank for overseas institutional investors borrowing stock on domestic markets, also lauded the regulatory relaxation.

“More investment instruments to QFII are available, including stock borrowing and lending,” said Rick Hu, head of securities services at Standard Chartered China. “Those businesses have always been the most attractive ones for overseas institutional investors."

William Ma, chief investment officer of Noah Holdings (Hong Kong), told CNBC this week that he expects initial public offerings on domestic markets will proliferate in 2021.

“In terms of the IPO size and volume in the China market, they have hit a historical peak in the past 10 years,” said Ma, adding that the trend is likely to continue on “huge demand” from domestic and foreign institutional investors.