China’s market rebound in second half looks unlikely as policy tightening will hold back rally, BCA Research says

A rebound in China’s onshore stocks will probably lose traction in the second half, as a shrinkage in aggregate financing foreshadows a moderation in economic growth and policy normalisation is set to continue to avert asset bubbles, according to BCA Research.

The Canadian research firm continues to recommend an underweight position in yuan-denominated stocks on the Shanghai and Shenzhen exchanges after downgrading the shares by two notches from January to March.

The recent uptick in Chinese stocks has largely been underpinned by overseas inflows betting on a further strengthening of the yuan, Sima Jing, a strategist at BCA, wrote in a report dated June 16.

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The benchmark Shanghai Composite Index had risen 5 per cent through Tuesday since a March 10 low. It dropped almost 1.1 per cent on Wednesday.

“China’s domestic policy backdrop and economic fundamentals do not support a sustained rally in Chinese stocks in the next six months,” the report said.

Policy tightening has not reversed course and there is an escalating risk that economic data will surprise the market to the downside in the third quarter.”

The risk of overtightening of policies is building up as official data showed that deceleration of credit growth gathered traction in May, with shadow banking and local-government bond issuances contributing to most of the contraction, the report said.

The moderation will continue into the second half, and risks missing the full-year government target for credit growth, it added.

The lack of market breadth is also another reason BCA remains bearish on Chinese stocks. The foundation to build on the rebound remains shaky, as the recovery has so far been led by only a handful of companies, with the ratio of rising stocks and falling ones being low, it said.

“Such narrow breadth suggests that the rebound in Chinese stock prices will not sustain,” Sima wrote in the report.

Technically, the underperformance of cyclical stocks, which are proxies for the economy, relative to defensive ones, has also heralded a downbeat outlook of the economy based on the historical data, it said.

Even with sentiment turning weak in the coming months, the chances of top policymakers in Beijing reversing policy tightening in the near term are low.

“Given that global growth is robust, Chinese policymakers will not feel any urgency to reverse policy setting and will likely use the strong external environment as an opportunity for domestic deleveraging,” the report said.

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