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Market Overview

Market Overview

Overview July, 2015

Author: John Hsu/Thursday, July 9, 2015/

China

In our write-up dated June 22nd (http://tinyurl.com/sycee), we shared our view that a correction in general is healthy for capitalmarkets. The Shanghai market up to its recent peak in mid-June, rallied 112% without any consolidation. So, a healthy correction was long overdue. This round of liquiditydriven rally in the A-shares market has led stock prices to climb to unreasonable levels with valuations that detach from fundamentals. It is therefore normal that market forces will drive asset prices back to their intrinsic value level.

The recent sharp decline was triggered by the initial curtailment of margin trading mandated by the government and then exacerbated by deleveraging en masse. In other words, highly leveraged margin accounts were forced to liquidate, leading to an across-the-board decline, which in turn triggered further liquidation. Initially, the government underestimated the ripple effect of margin deleveraging. However, at the time of this writing, the Chinese central bank, PBoC, together with various government agencies, announced a series of measures to provide liquidity support and to stabilize market expectations. As an example:

  1. 1. PBoC will “provide liquidity assistance” to China Securities Finance Corp (CSF) to enable it to better play its role in financing securities trading and propping up the A-shares market;
  2. 2. CSF will extend RMB260 billion (US$42 billion) of credit lines to securities firm which can then make loans to investors to buy stocks;
  3. 3. China Insurance Regulatory Commission (CIRC) will increase the threshold to 10% from 5% of the investment in a single blue chip company by the insurance companies;
  4. 4. China Securities Regulatory Commission (CSRC) will allow major shareholders to increase stakes in listed companies of SOEs without approval.

This enhanced policy support is in line with our expectation that the government will impose a “policy put” in order to prevent unintended, widespread financial system risk. We believe that the correction will be contained and stabilized in the near future. At this juncture, perhaps what is more important is to balance the current bearish viewpoint with a review of the current state of the Chinese economy. We believe that fiscal and monetary policies will continue to be accommodative so as to sustain an economic recovery. Furthermore, with active brokerage accounts being less than 10% of Chinese households, we believe that the overall impact of the recent sharp decline on consumer spending will be insignificant.

Post correction, Chinese equity has now become more attractive, e.g., MSCI China now trades at 9.2x on a 12-month forward P/E, at a 22% discount to its 10-year average. The A-share benchmark CSI300 now trades at 13.5x on a 12-month forward P/E, at 9% discount to its 10-year average.

Looking forward to the remainder of the year, we will continue to closely monitor the market recovery, policy actions and buying opportunities in the capital market.

We continue to be optimistic about a Chinese economic recovery and deem current market valuation as reasonable.

Greece

Greece has been an issue ever since the foundation of the EU and the adoption of a single currency. Much of the data regarding its eligibility had been a problem. Greece’s admission to the Union was a matter of political convenience on the part of all parties rather than solid eligibility. Simply put, Greece never was able to repay its debts, and the EU led by Germany was always willing to provide another Band-Aid. Now it has come to pass that in trying to employ the same tactic one more time, Mr. Tsipras has discovered that there is a line in the sand, and Chancellor Merkel and the rest of the EU stand resolute in demanding austerity on the part of the Greeks. Therefore, the issue at hand has very quickly shifted from economic to political. It is hard to see how the Greek people can endure sustained austerity and self-sacrifice.

On the other hand, Chancellor Merkel and her allies are also a little bit behind the eight ball. General elections are set for the fall in Spain and everyone is fearful that what happens to Greece may likely be a precursor for Spain.

In the meantime, in his game playing, Mr. Tsipras has resorted to exchanging frequent phone calls with Mr. Putin in Moscow. The West, in general, is fearful of Russia being brought into the fold under any circumstances. It would appear ghastly if Russia were among the first to provide emergency humanitarian aid to the Greeks.

So at this eleventh hour, it is still likely that the EU will be the one to blink first and accept the terms proposed by the Greeks. Such an agreement to austerity and the restructuring of debt by the Greeks is a charade, but it would permit both parties to “save face.”

The promise of austerity that can never be fulfilled and the prospect of restructure would put off the necessary hard decisions for another day.

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