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Takeaway: For the time being, China’s economic fundamentals and catalyst calendar support buying the dip in Chinese equities.

SUMMARY CONCLUSIONS:

  • To some extent, today’s “puke” instructs us that our initial interpretation of the tightening measures was not bearish enough. For the time being, however, China’s economic fundamentals and catalyst calendar support buying the dip in Chinese equities. For instance, the 12th National People’s Congress commences tomorrow and we expect to see a fair amount of positive headlines in the way of meaningful economic reforms.
  • If the People’s Congress goes as expected from a headline perspective and the Shanghai Composite holds TREND support (2,208), today’s aggressive price declines have presented a great buying opportunity in Chinese shares.
  • Conversely, if China snaps its TREND line on the back of disappointing policy-related headlines and further consternation surrounding the pending health of the country’s property market, we’ll be quick to abandon our bullish bias with the intent of once again digging into China from a short-seller’s perspective – something we have a good track record in doing (refer to our 1Q10 Macro Theme: Chinese Ox In A Box, where we were out front calling for similar policy-induced economic weakness that ultimately went on to characterize the last ~3yrs of the Chinese economy).

Overnight:

  • The Shanghai Composite indexed dropped -3.7% day/day, the largest 1D decline since AUG ’11;
  • The CSI 300 Index dropped -4.6% day/day, its largest 1D decline since NOV ’10; and
  • The Shanghai Stock Exchange Property Index dropped -9.3% day/day, its largest 1D decline since JUN ’08.

It appears the full impact of Friday’s macroprudential tightening in the property market wasn’t fully digested by market participants until today. To bring you up to speed, we detail the measures and their likely impact(s) in the following note: “THE BAD NEWS IS OUT OF THE WAY IN CHINA” (3/1).

In short, while we think this latest round of tightening measures is definitely impactful, they are not nearly as negative as we initially feared. The heightened concerns mostly stem from the new 20% capital gains tax on existing home sales; prior to Friday’s announcement, existing home transactions were taxed at a rate of 1-2% of the sale price.

To some extent, today’s “puke” instructs us that our initial interpretation of the tightening measures was not bearish enough. That said, however, rather than react to headline-grabbing 1D % change moves, we turn to our quantitative factoring for true guidance.

On this metric, the Shanghai Composite is still healthily bullish from an intermediate-term TREND perspective and continues to support our bullish intermediate-term fundamental bias on Chinese equities. If, however, the now-confirmed immediate-term TRADE breakdown is but a leading indicator for further breakdowns, then we’d happily abandon our bullish bias upon confirmation of that signal.

CHINA PUKES - China SHCOMP

For the time being, however, China’s economic fundamentals and catalyst calendar support buying the dip in Chinese equities. For instance, the 12th National People’s Congress commences tomorrow and we expect to see a fair amount of positive headlines in the way of meaningful economic reforms.

Additionally, China’s MAR growth figures are almost certain to improve sequentially from the Lunar New Year-impacted FEB figures – such as the FEB NFLP Services PMI, which ticked down to 54.5 from 56.2 (dragged down in part by a -1.9 ppt. drop in the New Orders subcomponent to four-month low of 51.8).

All told, this week will be a critical week for investors in Chinese equities. If the People’s Congress goes as expected from a headline perspective and the Shanghai Composite holds TREND support (2,208), today’s aggressive price declines have presented a great buying opportunity in Chinese shares.

Conversely, if China snaps its TREND line on the back of disappointing policy-related headlines and further consternation surrounding the pending health of the country’s property market, we’ll be quick to abandon our bullish bias with the intent of once again digging into China from a short-seller’s perspective – something we have a good track record in doing (refer to our 1Q10 Macro Theme: Chinese Ox In A Box, where we were out front calling for similar policy-induced economic weakness that ultimately went on to characterize the last ~3yrs of the Chinese economy).

Darius Dale

Senior Analyst