By Mark Galasiewski
The Shanghai Composite Index is forming an important low at the start of a significant advance in Chinese stocks. The following charts and text present a portion of the evidence to support the bullish case: valuation considerations.
After a large-degree bear market like the one since the 2007 high, even asset valuation measures can become useful tools of technical analysis.
Value investors cherish measures of fundamental value, such as price/earnings (P/E) ratios and dividend yields, to help them decide whether a stock is expensive or cheap. But the wide and inconsistent range in such metrics shows that they are only byproducts of the same non-rational forces that drive stock trends. In financial markets, unlike economic markets, value exists only in the minds of the collective — that is, price reflects (subjective) consensus, not (objective) supply and demand. Therefore, asset multiples rise along with swelling optimism during large-degree advancing waves and then hit bottom along with investor sentiment near the end of large-degree declining waves. It's really that simple.
Viewed from that perspective, the record low in the Shanghai A-shares P/E ratio at present supports our view that the Shanghai Composite is forming a major low near the lower line of the index's long-term trend channel from the early 1990s. (See first chart.) At the same time, the dividend yield for Shanghai A-shares is approaching parity with the yield on 7-year government bonds. (See second chart.) The previous two times that Chinese stock and bond yields reached parity, in late 2005 and late 2008, it marked the start of multi-month bull markets in the Shanghai Composite.
A Bearish Consensus Builds
Despite such growing evidence in the wave patterns that Chinese stocks may soon offer a textbook long-term investment opportunity, conventional observers have become bearish on China. When coupled with the technical arguments we presented above, this negativity is bullish from a contrarian perspective.
Near the peaks of 2007 and 2009 in China's stock market, headlines and book titles touted a bright future for China. The pendulum has now swung to the other extreme. China's Prime Minister Wen Jia Bao says that the nation's economy faces "huge downward pressure." A prominent Chinese economist said that Chinese investor sentiment is the "most bearish ever." A former visiting foreign professor at a Chinese university has written a book called The End of the Chinese Dream: Why Chinese People Fear the Future. A Barron's cover describes China as a "Falling Star" and claims that its economy "is slowing and is likely to slow a lot more."
The mainstream media has grown so pessimistic about China that the New York Times even wrote an article about it titled, "China's Economy: Apocalypse Soon?" The article noted that:
- Foreign Policy magazine published a review of the economy called "Five Signs of the Chinese Economic Apocalypse."
- The New Yorker magazine asks "Is China Running Out of Steam?"
- The Business Insider website listed "Fifteen Reasons Why Everyone Is Suddenly Freaking Out About China."
"I can't tell you precisely when the downturn will hit," a global investment strategist told Barron's. "No one can. All I know is that China has all the earmarks of a classic mania that will end badly — a compelling growth story that seduces investors into ill-starred speculation, blind faith in the competence of Chinese authorities to manage through any cycle, and over-investment in fixed assets with inadequate returns facilitated by an explosion in credit."
Such words would have been appropriate ahead of the 2007 or even the 2009 highs in the Shanghai Composite — but they weren't uttered then. Instead, today, with stock indexes near a major low, they have become the conventional wisdom. Because so many are so certain that a crash is starting, it should mean just the opposite: that a bullish opportunity in Chinese stocks is near.
[To see the full five-page report with seven original and information-packed charts, for free, visit www.elliottwave.com/ChinaBoom.]
Mark Galasiewski began his analytical career in 2001 at an institutional brokerage in Stamford, Connecticut. After joining Elliott Wave International (EWI) in 2005, Mark contributed to Robert Prechter's "Elliott Wave Theorist" and then joined EWI's Global Market Perspective team covering Asian stock indexes. Since 2008 he has also edited EWI's newest monthly market publication, the "Asian-Pacific Financial Forecast." For six years during the 1990s he lived in Japan, where he observed that country's extended bear market first-hand. Since joining EWI, he has presented at several investment conferences in Asia and has been interviewed by major Asian media outlets such as Bloomberg TV in Hong Kong, Japan and India, India's CNBC TV-18 and ET Now, Bloomberg newswire, Dow Jones Asia newswire and Press Trust India.
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