Is the party over for A Shares?

After the strong showing by the Shanghai exchange in 2014, we weren’t surprised recently to see so many China funds on the ETFG Quant Movers report.  It also got us thinking about whether investors looking to buy these international equities cheaply had already missed a good deal.

There may be numerous parallels between China in 2014 and Europe in 2015: concerns over a weak banking system, sustainability of the investment led GDP growth model and a once-a-decade political transition that punished the China A-share market for years and pushed share prices of many of the largest banks below book value.  Actions by the PBoC and the central government to prevent major defaults in the high yield investment trust market (as well as opening the A-share market to further outside investment) offered investors a guide map to what policy actions investors could expect to support the market while shifting the economy from an investment-driven to a consumer driven model.  But like their European counterparts, it would be hard to call the A-share funds a good bargain after their 53% run-up in 2014.  While the ETFG fundamental score for the largest A-share fund, the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR) is still attractive relative to its own history, the trailing P/E of 14.72 is hardly a bargain.

Another factor to consider before taking the plunge into a China fund is the currency peg between the Chinese Yuan and the U.S. dollar; since the July 1^st 2014 the U.S. dollar has gained over 30% compared to the Euro but only .83% versus the Chinese Yuan as the PBoC works overtime to keep the currency peg within its established trading range.  That peg has helped support the strong rally in the A-share market but investors relying on the Chinese Communist Party to maintain the Yuan at its current levels might want to think again.  While China’s trade surplus hit a new record in February as rising exports to America help counteract the fallout from the Yuan’s 30% appreciation versus the Euro, the PBoC’s balance sheet experienced a major contraction last quarter as capital continues to flee the country and forces the central bank to intervene to support the value of the Yuan.

Lastly, a current account surplus and capital account deficit seem to be the natural order of things for the rest of the world, but it has added another element of instability in China’s transition towards a consumer-based economy.  Given the size and importance of China’s trade relationship with the EU, there is a significant amount of debate as to whether China will continue to defend the Yuan as its current levels or allow a one-time depreciation despite the concerns that it could add further instability to the market.

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