Bangkok--1 Mar--Standard & Poor's
Emerging Markets And Small Caps Will Bear The Brunt Of The Selling
The near 10% decline in the Shanghai and Shenzhen 300 Index yesterday after authorities in Beijing announced increased efforts to prevent speculation by banning margin trading and clamping down on illegal share offerings was not unexpected, according to two new reports published today by Standard & Poor's Equity Research, given the index's near doubling over the past year, its high valuation and low liquidity. The initiatives are likely to drive Chinese domestic markets lower and further measures may be required to curb increased speculation in local equity markets. For a copy of the reports, titled "The China Syndrome" and "China: Taming Of The Sow," please email one of the media contacts listed below.
"Not a pleasant start to this Year of the Pig, but what we had been expecting - a correction in the China markets - has occurred," said Lorraine Tan, Vice President of Standard & Poor's Equity Research in Asia. "Nevertheless, the falls in the global markets that followed were somewhat surprising and is indicative of the increasing significance of Chinese fortunes."
Commenting on the sell off in developed markets in the U.S., U.K., Canada and Europe, Standard & Poor's Equity Research international strategist Alec Young said investors were increasingly worried that, just as China's growth has helped the rest of the world expand over the past several years, any significant slowdown will have a commensurately negative impact. In addition, with volatility at record lows after an uninterrupted 8 month-rally, many global stock markets were vulnerable to profit taking as risk aversion spiked from unsustainably low levels.
"We see the current malaise as a correction within a longer-term bull market rather than the beginning of a major bear market. Higher beta asset classes like emerging markets and small caps in both the U.S. and internationally will likely decline most with a flight to quality helping global blue chips fare slightly better," Mr. Young said. "But ultimately, the answer will lie in the health of the global economy and how well it weathers any China slowdown."
Further downward consolidation for China A-shares, which Standard & Poor's Equity Research believes remain overvalued, may be required to place regional markets on firmer footing for the remainder of the year. "For other regional markets, we see sharp falls in the higher beta exchanges such as Malaysia, which had in any case been outperforming and whose own valuations were reaching levels where risk versus upside was heightened," Ms Tan said. Standard & Poor's Equity Research remains "Underweight" China A-shares and continues to prefer Hong Kong, Taiwan and Korean issues.
"Importantly, we believe the overall regional economic and corporate fundamentals remain intact. Hence, while we expect further near-term underperformance, potentially triggered by margin-calls, we regard the sell-off as healthy and anticipate regional markets to stabilize as they are nearing fundamentally supportable values."
Standard & Poor's Equity Research continues to expect China 2007 GDP growth to come in around 9.5%-9.9% underpinned by healthy exports, investments and domestic consumption. With recent economic indicators pointing to more sustainable growth levels, we believe the government's focus will intensify on reducing excess liquidity and potential bubbles.
"While we note that the government prefers to avoid policies that may impede the growth of rural income, we suspect that it may resort to allowing interest rates to rise should current specific measures have a limited impact," Ms Tan said. "We also expect recent measures to curb property speculation to have an effect but the increased speculation in the equity market may require new measures. These could include additional direct policies such as more stringent trading limits and reduced lines to brokers. Regardless, the excess liquidity, which is fed by healthy economic growth, may ultimately require higher interest rates."
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