July 16, 2015 taxitime

Update on the Chinese Sharemarket – July 2015

Update on the Chinese sharemarket

China’s sharemarkets have fallen sharply in the last month. The main Shanghai Composite Index has fallen 32% since June, and this has been matched by falls in the smaller Shenzhen Stock Exchange and in Hong Kong listed China shares. This follows a remarkable 160% increase from May 2014 to 12 June 2015. Despite the recent falls, Chinese shares are still up 72% this year to 10 July 2015.

The substantial decline reflects a number of factors, but primarily the over-valuation of smaller shares in China. The five year average price-to-earnings ratio (which is a common valuation measure) of Chinese shares is 12. The ratio for Australian shares is 16 to 17. At the end of May, 1,100 Chinese stocks had a price-to-earnings ratio of greater than 100. As investors began the process of taking profits in these smaller companies, selling accelerated and, over the last week, has increased dramatically.

The policy response

China has encouraged the rise in shares prices, for two reasons.

1. Chinese households have been hit by a slowdown in the property market that accelerated through 2014. Shares have offered an alternative investment opportunity so many investors have directed their attention to shares.

2. Firms in China have not been able to use equity financing to fund themselves (i.e. they haven’t been able to sell their company shares to investors to raise capital), because, it was very expensive. As a consequence, Chinese firms have relied on bank loans. By allowing share prices to rise, China has helped increase the availability of equity financing for its firms.

This encouragement has been supported by a monetary easing by the People’s Bank of China (PBoC). The PBoC has lowered interest rates and allowed banks to lend against a higher proportion of their deposits. This has been a major loosening of monetary policy after two years of tight monetary policy. It is likely these measures will begin to have a positive impact on the economy in the first half of 2016.

As share prices have fallen, there has been limited intervention by Chinese authorities. Indeed, it could be argued that the selling of smaller firms was viewed positively and an important development in allowing share prices, broadly, to increase more sustainably over the coming months and years. On Monday July 6, China’s Premier, Li Keqiang, failed to even mention the recent falls on the sharemarket in a commentary on the Chinese economy. This would support the view that the correction was seen as healthy.

The sell-off however, continued last week, coupled with more desperate tactics by listed companies. Many of the smallest firms in China have put themselves into a trading halt. This stops trading in their shares. As a consequence, as investors have sought to raise cash, they’ve been forced to sell more liquid shares held in less over-valued large companies. This has intensified the market’s fall.

Consequently, China now seems to be actively supporting the Chinese sharemarket. The PBoC is providing market liquidity support by cutting deposit and loan rates and banks’ required reserve ratio. Large and small companies have been encouraged to buy their shares and bans on executive sales have been put in place. In time, the Chinese market should stabilise but we can expect the market to remain volatile in the shorter term.

Paris Financial Services Pty Ltd is a Corporate Authorised Representative (No. 357928) of Capstone Financial Planning Pty Ltd. ABN 24 093 733 969. AFSL / ACL No. 223135. Source: Colonial. Current as at 13 July 2015. Information contained in this document is of a general nature only. It does not constitute financial or taxation advice. The information does not take into account your objectives, needs and circumstances. We recommend that you obtain investment and taxation advice specific to your investment objectives, financial situation and particular needs before making any investment decision or acting on any of the information contained in this document. Subject to law, Capstone Financial Planning nor their directors or employees: • gives any representation or warranty as to the reliability, accuracy or completeness of the information; or • accepts any responsibility for any person acting, or refraining from acting, on the basis of the information contained in this document.

What are the potential consequences?

It’s unclear what the broader economic consequences of the market’s sell-off will be. The overall ownership of shares in China by households is both small and narrow so for these investors, the falls in the sharemarket has only impacted one part of their assets.

From an economic perspective, falling share prices will impact financial markets across China, including commodities such as iron ore. In the short term this will put iron ore prices globally under pressure. In the medium term, however, it suggests a greater level of policy support can be expected. This should help support activity and commodity prices moving forward.

Should you have any concerns or questions regarding your investments please contact Paris Financial.

Darren Foster – Senior Financial Adviser

Paris Financial Services Pty Ltd is a Corporate Authorised Representative (No. 357928) of Capstone Financial Planning Pty Ltd. ABN 24 093 733 969. AFSL / ACL No. 223135. Source: Colonial. Current as at 13 July 2015. Information contained in this document is of a general nature only. It does not constitute financial or taxation advice. The information does not take into account your objectives, needs and circumstances. We recommend that you obtain investment and taxation advice specific to your investment objectives, financial situation and particular needs before making any investment decision or acting on any of the information contained in this document. Subject to law, Capstone Financial Planning nor their directors or employees: • gives any representation or warranty as to the reliability, accuracy or completeness of the information; or • accepts any responsibility for any person acting, or refraining from acting, on the basis of the information contained in this document.

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