Will the economy push Chinese equities higher?

Chinese and Hong Kong markets dominated the front pages last week on news the regulator (CSRC) was relaxing rules around mainland mutual funds needing pre-approval to invest in Hong Kong stocks.

Source: Bloomberg

The fact, the Chinese central bank has moved to an easing bias since November, which has also acted as a strong catalyst in raising confidence.

The volumes seen through both China and Hong Kong have been outstanding, with HK$98.55 billion trading through the Hong Kong exchange on Thursday; this is over four times the five-year average. In turn, we saw the Hang Seng and H-share market (Chinese companies listed in Hong Kong) recording near-10 percent rallies.

Other observations from China:

- On Wednesday and Thursday we saw the full quota of permitted funds flowing from the mainland to the Hong Kong market. Clearly valuations in Hong Kong were extremely compelling for mainland investors!

- There was clear outperformance by the Hong Kong market, with the Hang Seng outperforming the mainland CSI 300 by 4.2 percentage points on the week.

- Since the beginning of March, 5.74 million new A-share accounts have been created, with a wall of new money coming into the market.

- Regulators are now allowing investors to have up to 20 A-share accounts at any one time, which is in turn providing increased flexibility.

- Outside of equities, the CSRC is also relaxing the limits around the level of futures contracts, allowing traders to hold up to 5000 contracts (from 1200). It doesn’t seem like we are seeing a strong clamp down on speculative activity just yet.

- Liquidity has been abundant, with the seven-day repo falling to 3% from 4.6% in mid-March. This is providing support for equity investors.

- There has been increased narrative from officials, throwing caution around the pace of the buying that is underway. This has helped ease the pace of the buying, but traders still seem to be buying pullbacks.

One trade that has clearly worked out well is being long the Hang Seng (called HS50 cash on IG's platform) or H-share index, with many also looking to be short the CSI 300 as a pair’s trade and simply net off the performance. This seems to be a fairly mature trade now and I would caution about initiating new longs from here, preferring to wait for a pullback.

There are plenty of catalysts this week for the Chinese markets and economics could play a greater role. In focus we have the March trade balance today (expected to narrow to $40.1billion), with exports expected to grow 9% while imports decline 10%.

On Wednesday we get retail sales (consensus is calling for 10.9% year-on year growth), industrial production (7%), fixed asset investment and Q1 GDP (7%). Will the economic impact investor sentiment or will worse-than-expected data increase the idea of further easing measures and boost equities even higher?

Technically (I have looked specifically at the China H-shares cash), the daily chart is showing overbought conditions if we look at the various oscillators. However, these conditions are a pure reflection of the explosive momentum in the market and the rapid rate of the change in price.

Looking at Friday’s candle we can see strong buying coming into the market into 13,700, just as we did on Thursday. This re-enforces the idea of buying dips in this market.

I also think it is interesting to see the monthly chart, which shows a clear triangle break in November; this pattern suggests a target of 16,150 – 13% higher than current levels.

The 61.8% retracement of the decline seen between 2007 and 2008 at 14,570 has been tested and the fact that sellers have come into the market suggests this level is being respected. A break of this level is clearly needed, so this level seems key for the bull market to continue.

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