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Does everyone really think that China is heading for crisis?

Headlines in business newspapers have never been short of bad news from China. Be it weak economic data, worrying signs of financial risks, or an unexpected fall in the renminbi, it seems there is a consensus among business journalists that China is on the verge of collapse.

The market, however, disagrees. The Hang Seng China Enterprise index rallied in the latter part of March. Is this just evidence of market irrationality and that Chinese stock prices simply diverge from economic reality? Or is there a more reasonable explanation?

First, does everyone really think that China is heading for crisis? It is the world's second-largest economy and, with expectations that its gross domestic product will grow by 7-8 per cent this year, it is arguably the most important growth engine of the global economy.

If everybody really thinks that China's economic growth is bound to disappoint, why would the S&P 500 break new a high in March? Why would the gold price fall 7 per cent from the recent peak? And why would the Federal Reserve continue to reduce monetary support of the US economy and signal an interest-rate hike early next year?

Second, Chinese stocks could hardly get cheaper. They are priced according to extreme pessimism, and it doesn't need much good news to spark a rally. The H-shares banking sector is trading below the level of 2008's sub-prime crisis with a price-to-book ratio at 0.9 and price-to-earnings ratio of 5. The broad market P/E ratio is at a 40-per-cent discount to Asian peers and a 60-per-cent discount to the US.

Third, Premier Li Keqiang's pledge to support the economy helps. Above all, the slowdown in China is intentional. The government has attempted in the past few years to engineer a soft landing and shift growth away from investment towards a more sustainable consumption-driven economy.

In a recent speech, Li signalled a more dovish stance. He admitted the increasing downward pressure on the economy and said "the government had policies well prepared and would roll out targeted measures step by step to aid the economy".

The stock market has always been known as a leading indicator of the economy. As such, current stock prices should have already reflected the well-publicised facts about rising financial risk in China. Negative news flows might continue to weigh on the market, but provided the extremely cheap valuations, Chinese stocks might have found the bottom.

Komsorn Prakobphol is a senior investment strategist at Tisco's Economic Strategy Unit. He can be reached via www.tiscowealth.com or komsorn@tisco.co.th.


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