What s next for Chinese shares

Shanghai stocks have jumped at the fastest pace for 7 years in the last two days. We had predicted a share price rise after the precipitous sell off earlier this week, as you can see HERE: http://www.cityindex.co.uk/market-analysis/market-news/38305652015/are-chinese-stocks-due-a-rebound/ The market duly responded, so where will Chinese markets go next?

To answer this question we need to look at it from a few angles:

1, Volatility:

We noted last week that the Chinese index was due a rebound because volatility had spiked to one of its highest ever levels. Typically, when volatility spikes, it can mark the bottom of the market and we can see shares rise and volatility start to moderate during the following trading sessions. However, in another sign that China walks to the beat of its own drum, Chinese shares have rallied some 15% in the last two sessions, yet volatility has surged to a record high above 80. This is to be expected, after all, a 15% move in two days is extremely volatile, whatever the direction. But with volatility remaining at this high level we think prices could be extremely choppy in the coming week with prices swinging from sharp lows to sharp highs almost overnight. Thus, we don’t think that the price action of the last couple of days means that Chinese stocks are out of the woods yet, and they could still suffer some sharp sell offs.

Figure 1:

Source: FOREX.com, Data: Bloomberg

3, China’s version of QE

In recent weeks China has shown its willingness to help support its tumbling stock market. Chinese authorities cut borrowing rates, it banned large shareholders from selling their positions and a Chinese state investment vehicle has been tasked with buying shares (although these shares do not lie on the PBOC balance sheet). With nearly half of all companies listed on the Shanghai Composite still not trading after being suspended last week, the government intervention has seriously distorted price action.

Some expect even more supportive action to come from the Chinese central bank, including another large interest rate cut (China last cut rates at the end of June, when they were cut by 25 bps to 4.85%), which could see China join the zero-rate club in the coming months and years. If this happens then it could boost the attractiveness of the Chinese stock market and see an extension of the recovery that we have seen in recent days.

This week’s critical economic data (see below), could hasten further action to support the stock market by the central bank, particularly if the economic data surprises to the downside.

4, Economic data

This week’s critical release will be Chinese Q2 GDP, which is released on 15^th July. The market is expecting GDP to fall to 6.8% from 7%. If we see a sharper than expected decline, say 6.5% or below, then we could see panic set in about China’s future economic prospects, and more selling in the Shanghai Composite. However, this would also be the time when we would expect to see the Chinese authorities intervene with more stimulus measures. Thus, if we do get weak economic data in the coming days, expect another volatile period for Chinese stocks.

Takeaway:

As you can see, the outlook for Chinese stocks is not clear cut, and there are as many reasons for stocks to fall as there are for them to recover. However, if Chinese markets are to embark on another uptrend, it may require even more state support, so watch out for the PBOC and a further rate cut. This is important for markets outside of China including the ASX in Australia, the Hang Seng, the Nikkei and commodities.

Source: FOREX.com, Data: Bloomberg

2, China ignores external fears:

The investment community may be focused on Greece, however, do not expect China to celebrate if Greece seals a deal with its creditors. As you can see in figure 2, volatility in the German Dax is less than half that in the Shanghai index. China doesn’t move in the same way as other indices and may not react to the Greek crisis, instead focusing on domestic issues in the days ahead.

Figure 2:

Source: FOREX.com, Data: Bloomberg

3, China’s version of QE

In recent weeks China has shown its willingness to help support its tumbling stock market. Chinese authorities cut borrowing rates, it banned large shareholders from selling their positions and a Chinese state investment vehicle has been tasked with buying shares (although these shares do not lie on the PBOC balance sheet). With nearly half of all companies listed on the Shanghai Composite still not trading after being suspended last week, the government intervention has seriously distorted price action.

Some expect even more supportive action to come from the Chinese central bank, including another large interest rate cut (China last cut rates at the end of June, when they were cut by 25 bps to 4.85%), which could see China join the zero-rate club in the coming months and years. If this happens then it could boost the attractiveness of the Chinese stock market and see an extension of the recovery that we have seen in recent days.

This week’s critical economic data (see below), could hasten further action to support the stock market by the central bank, particularly if the economic data surprises to the downside.

4, Economic data

This week’s critical release will be Chinese Q2 GDP, which is released on 15^th July. The market is expecting GDP to fall to 6.8% from 7%. If we see a sharper than expected decline, say 6.5% or below, then we could see panic set in about China’s future economic prospects, and more selling in the Shanghai Composite. However, this would also be the time when we would expect to see the Chinese authorities intervene with more stimulus measures. Thus, if we do get weak economic data in the coming days, expect another volatile period for Chinese stocks.

Takeaway:

As you can see, the outlook for Chinese stocks is not clear cut, and there are as many reasons for stocks to fall as there are for them to recover. However, if Chinese markets are to embark on another uptrend, it may require even more state support, so watch out for the PBOC and a further rate cut. This is important for markets outside of China including the ASX in Australia, the Hang Seng, the Nikkei and commodities.