China’s markets experienced their strongest two-day decline in nearly six years last week. This led to fears that the world’s strongest market rally was ending. However, in a remarkable recovery, stocks have rebounded for two successive days this week. While this raises the familiar specter of volatility, it also raises questions about whether China’s record-busting rally is still sustainable.
Two-Day Plunge
The Shanghai Composite plunged 6.5% on Thursday, marking the largest decline in four months. Losses were caused by the decision of brokerages to increase restrictions on lending. Meanwhile, the country’s central bank pulled out money from the financial system via the sale of repurchase agreements to specific financial institutions.
Financial and commodity stocks weighed on the broader market. Additionally, concerns over the launch of more IPOs also dampened investor sentiment. Analysts opined that another round of profit taking was taking place.
Stocks declined for a second successive day on Friday, with the benchmark index losing 0.2%. Market watchers took the view that the record breaking rally had been continuing for too long and at an unsustainable pace. Over last week, the Shanghai Composite declined 1%.
Following Thursday’s losses, seven successive days of gains came to a close. During this period, the benchmark gained 15% and nearly crossed the 5,000 mark for the first time in eight years.
Market Resurgence
The Shanghai Composite rebounded on Monday, gaining 4.7% to close at its highest level since January. While government manufacturing data indicated an expansion for the third successive month, further government reform measures also boosted stocks. China’s ministry of finance is likely to take steps to improve the debt situation of local governments.
Stocks gained for a successive day on Tuesday, following optimism that additional steps will be taken by the government to boost the economy as well as earnings results. China’s benchmark index moved up 1.7%, negating a 0.7% loss incurred earlier during the day.
The CSI 300 Information Technology Index gained 4.2% to touch record levels. This sub-index has surged 137% in 2015. The current advance was a result of investors’ belief that such stocks would post better earnings. New economy stocks are emerging as the clear favorite among investors, reflecting in gains made by the ChiNext and Shenzhen indexes.
The Shanghai Composite has gained 52% year-to-date and leads all other global benchmarks. A series of reductions in interest rates over the months has helped to boost optimism about the economy.
What Can Sustain the Rally?
Analysts and market watchers alike believe that investors will have to brave volatility. Currently, volatility is at its highest level in five years. But the bigger question is whether the stock market rally is sustainable. There is no doubt that the economy is improving, as is indicated by manufacturing data. Challenges remain, but the effect of government measures is already being felt.
The role of the government can also be directly felt when it comes to equity markets. Following Friday’s plunge, the country’s central bank declared that it desired “healthy” equity markets. Additionally, state owned newspapers also said that the essential forces behind the bull run remained in place.
According to them, major reform measures and monetary stimulus were the factors which had sustained the rally. In particular, the country’s market regulator has taken several steps to reduce the role of speculators and improve the trading environment.
Additionally, despite the surge in stock prices, valuations continue to be low. Last week’s decline reminds traders of a similar plunge on May 30, 2007. According to Bloomberg, the benchmark currently has a price-to-earnings ratio of 18. This is 60% lower than the record levels it touched in 2007.
The Hong Kong-Shanghai exchange link has also provided greater access to international funds. Another link, this time between Shenzhen and Hong Kong, is expected to begin this year. According to EPFR Global, $4 billion or more worth of global capital was invested for the week ended May 27.
Our Choices
Below we present three stocks set to benefit from these trends. Finding a great growth stock can be a tough task. But thanks to our new style score system we have been able to identify a few growth stocks which have incredible potential in the near term.
Our research shows that stocks with Growth Style Scores of ‘A’ or ‘B’ when combined Zacks Rank # 1 (Strong Buy) or Zacks Rank #2 (Buy) offer the best investment opportunities in the growth investing space.
Huaneng Power International, Inc. HNP develops, constructs, owns and operates large coal-fired power plants throughout China.
Huaneng Power holds a Zacks Rank #2 (Buy) and has a Growth Style Score of ‘B.’ The company has expected earnings growth of 32.7% for the current year. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 8.12.
China Mobile Ltd. CHL offers mobile communications services across Hong Kong and Mainland China.
Apart from a Zacks Rank #2 (Buy), China Mobile has a Growth Style Score of ‘B.’ The company has expected earnings growth of 16.2% for the current year. It has a P/E (F1) of 12.97x.
Noah Holdings Ltd. NOAH through its subsidiaries is engaged in providing independent services primarily comprising distribution of wealth management products to the high net worth population in China.
Noah Holdings holds a Zacks Rank #2 (Buy) and has a Growth Style Score of ‘B.’ The company has expected earnings growth of 30% for the current year. It has a P/E (F1) of 22.01x.
Several factors indicate that China’s phenomenal market rally is likely to continue. This bodes well for investors, who are already crowding into markets in a big way. The promise of strong growth, backed by strong fundamentals means these additions would make good additions to your portfolio.
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