China remains a market bright spot

The reaction to the PBoC’s rate cut yesterday was like déjà vu to the previous two seen over the past six months.

Source: Bloomberg

The market popped on the open, shed all intraday gain by lunch, and then recouped around two-thirds of the morning’s gains in the final session of the day. The interesting thing about the moves yesterday was the size – the Chinese markets finished up around 1.5% on average (Shanghai, the stand out, was up 3% on retail listings). Compare that to the 5% market moves on the announcement that the reserve requirement ratio would be cut by 50 basis points. This suggests the market was slightly disappointed by the 25 basis-point cut to the benchmark lending rate.

I understand that the CSI and A50 are substantially higher than before and valuations in China are being questioned. However, the fact the PBoC is clearly signalling its willingness to act to support growth should be a sign that further action is likely and may even happen in the next two weeks if tomorrow’s retail sales, fixed asset investment and the key piece of industrial production data are not at a level that will help achieve the GDP estimate of around 7%.

In my eyes, China remains the key driver of the Asian region - growth is likely to come from internal changes to consumption and I believe we are beginning to see these changes in the trade data and manufacturing metrics.

Imports in the past three months have collapsed – double-digit percentage declines clearly show China is looking to itself for needs. Exports are also under pressure (but nowhere near as weak as imports) as every major global region has slowed consumption of Chinese goods. Yet China’s service PMI is still expanding at a healthy rate. Retail sales are down but nowhere near as badly as what is happening in industrial production. Confidence remains solid.

The reduction in interest rates will be a further positive for internal consumption and the reaction in the Shanghai Composite suggests investors see the same thing considering the high amount of retail listing on the index. So in short the PBoC is likely to move again to support internal growth.

Ahead of Australian open

The ASX continues to decline on its own issues. The bond rout overnight will do nothing to slow the declines today and the futures market is pointing to the ASX crossing the 5500 point handle. We are calling the market down 38 points to 5587 on leads from overseas.

The banks remain the biggest concern – NAB is back online this morning after its $5.5 billion raising and will quickly catch the other three in a technical correction. Since their highs in March, all four have declined a minimum of 14% (that’s a correction and more).

The issue is that, even with these declines, the fundamentals still don’t suggest they’re cheap. FY15 P/E for the group is 13.6 times; they are trading at 9 times pre-provision profits and 2.1 times book value – none of those metrics suggest good value.

However, while they might look cheap versus term deposits and other simple money market instruments on a yield basis, the banks appear very risky on a total return basis with the backend of the yield curve in bonds ticking up due to the global sell-off. There will be a natural yield floor, which I see kicking in around 5.1% (net yield). Even this may not be enough to stop the rout in the interim and suspect they will overshoot.

Telstra is the case in point to the bond switch trade – it has now declined over 31 cents in the past five trading sessions. TLS could be considered the ‘truest’ equity yield trade, considering its payout ratio is 100% and operations are still suggesting this will be maintained to the end of FY15. However, the natural pull of the bond market is undoubtedly attracting funds out of TLS and back to its normal allocation of sovereign bonds.

Finally, the budget is here – the main theme so far in the pre-budget rambling has been: how do we raise taxes without saying we are raising taxes? Joe Hockey has an interesting sell.

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