Chinese markets hit multi-month highs within a short period of 6 months and have almost cracked 20% from recent highs within 2 weeks. Most Indian stock market commentators are busy harping on 2 points
1 - Margin selling pressure due to tighter government regulation [Partly correct]
2 - Money invested in China may be re-directed to India [Grossly Incorrect]
As usual, when the key objective of tv anchors is to fill in airtime and prove himself / herself smart, such loose comments are inevitable. Unfortunately, a vast majority of people end up following these very delusional anchors to find themselves on the wrong side of the fence.
Let me first put out a 5 year Chart of Shanghai Composite v/s Nifty from Yahoo Finance for a perspective
The bold green line is the path of Nifty whilst the thin blue line is Shanghai Composite
Shanghai was down and out in 2013 at almost half the value of the earlier peak when all emerging economies were in their corrective phases. It stayed there for a very long time with elections due in South Africa, India, Indonesia and developed nations like Germany.
Remember that to a large extent, China pegs currency values and undoubtedly, it is the largest holder of US T-Bills and German Bunds as a sovereign across the globe. China was [and is still] trying to build on as a hegemony country of the East [Like US hegemony in the West]. The South China Sea dispute was a major factor of concern highlighted by major investment banks as well.
Once the election tailwinds went out of the way and dollar strength started surging in second half of 2014, it started making a lot of sense for fund managers seeking 'alpha' returns that the Chinese market was one major pocket of opportunity. China is a major guzzler of steel, copper and zinc and base metal prices are down in doldrums globally for over 2 years now. Oil prices started cooling off and with Dow, FTSE almost near peaks, uncertainty in Europe and expensive emerging markets, it was no brainer that China was waiting to explode as far as fund managers were concerned.
The successful IPO of Alibaba gave things a positive fillip but this rise was too much too soon. Doubling of the entire index in 6 months and that probably meant tripling and quadrupling of some of the index heavy weights.
Statistically, this concept is known as "Regression To The Mean". In simple terms, it means that something that has been grossly overperforming / underperforming for a prolonged period of time will go contrary to that trend and allow averages to catch up. We see that with sales teams across sectors, thematic mutual funds and sectoral indices as well. [Law of Averages, as we say in cricket]
For instance, a sales team that consistently hits and exceeds sales targets for 3 or 4 quarters starts tapering and cooling off for a couple of quarters. On the other hand, sales teams that were down in the doldrums suddenly stage a comeback with good sales. Fundamentally there are many reasons for that but statistically, it is something that has been established well over time.
Let us take India itself for instance; In the 2005-2008 rally when we hit 6300+ for the first time in Nifty's history, FMCG and Pharma were steady overall but not rank outperformers. Cyclicals and Infrastructure was the buzzword. By the time the entire correction of 2008 peak corrected and we scaled 6300+ again in Nov '10, most of the stellar performers of 2008 were anywhere between 50% and 80% down. 2010 was the time when FMCG, IT, Automotive started becoming pet themes outperforming frontline indices and cyclicals [HUL was around 280 at Nifty Nov '10 peak and Asian Paints was around 350 (adjusted for stock split), Tata Motors hit lows of 125, Maruti 750 M&M 630]
From a global indices perspective, DJIA and DAX were rank outperformers in the 2010 to 2014 period. DAX rallied from 5750 levels to 11k+ levels despite the Euro-zone crisis; DJIA was at 10800 in Oct '11 and went on to scale 16k by end 2013. Nikkei more than doubled from 2012 to 2015. With all the After getting to these levels, the subsequent leg up has not been very inspirational. Euro-zone problems intact, massive QE, Shanghai was a rank under-performer in global activities. So what would law of averages indicate? It was time for the Chinese dragon to spit fire.
Early indications of the Chinese dragon waking up from slumber was the way it has been lapping up physical gold from the time gold went below 1450 dollars / ounce [and China has an almost 5 month order to delivery backlog! Details can be obtained from the LME notes and World Gold Council]
The way Chinese government is using T-Bills as collateral to fund massive infrastructure projects was a clear indicator of things to come.
By September 2014, the Chinese dragon woke up from slumber and started breaking out of some critical resistances one after the other. The problem was the rise in Chinese markets was too much too soon and pretty much an asset bubble with a lot of margin trades [leverage] Chinese central banking agents were absolutely right in implementing tighter leashes because an index that languished at less than 50% off old peaks for over 2 years suddenly shot up defying gravity big time. Media pundits are again harping along big time about China being in a bear market since it has breached the 20% fall from peak.
I am not even getting into Elliott Waves here - simple technical analysis tells you that large swings up or down tend to retrace at least 50% in nominal terms and 38.2% in semi-log terms. So for an index that has moved from 2200 levels to 5200 levels, a 50% retracement is very much on the cards that pegs the retracement to go to at least 3700 levels before resuming the next leg upwards.
A lot of Indian tv anchors are making an absolute fool of themselves by saying money will move out of China into India. Taking the major index stocks into account, Indian stock market is worth a little over 1 Trillion USD. Chinese penny stocks alone are worth 8 trillion!!
Right now, all focus is on the major Grexit and potential repercussions. The structural bull market in China is absolutely intact. In the short to medium term, it may slip to 3250 as well but it is poised to scale 7500 levels over the next 5 years. The current correction is severe simply because the meteoric rise was fueled by leverage and when deleveraging has been imposed, weaker hands will be taken out in the process. All said and done, some headwinds have to be negotiated.
If the Grexit crisis and contagion does hit global markets, then we may see the Dollar Index briefly kiss the 100 mark. After things cool off in Greece and the next innings of QE begins to alleviate the pain caused, we will in all likelihood see the Dollar Index cool off to about 90 levels. This is the time when the Indian Tiger and Chinese dragon will roar once again.
[What goes up must come down; smart money is always on the look out for alpha and hence regression to the mean / law of averages will play out across asset classes]
Just as we have Hang Seng Bees, we may soon get Shanghai / Shenzhen Bees in India and should that come through, it makes sense to have SIPs in that!
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