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China Stocks and the Tapering of U.S. Stimulus

Ralph Jennings

TAIPEI ( TheStreet) -- Investors complain it's hard to choose stocks in China. They say the country's A-share market is just plain dodgy. Despite an increase in the Qualified Foreign Institutional Investor, or QFII, quota last month, China still doesn't give foreign investor status to just anyone, meaning a lot of us couldn't buy shares of Chinese companies even if we dared to.

Now China is saying its turn has come as other Asian markets fall on prospects of reduced economic stimulus in the United States. That would mean relative stability for Chinese stocks as the Federal Reserve unwinds five years of quantitative easing measures to stimulate an economy that's been sick for that long.

Round one of U.S. quantitative easing in 2008 and phase two in 2010 lifted Chinese A-shares, along with their peers around emerging Asia.

But A-shares, being state controlled, do not necessarily move up or down in concert with the other emerging Asian markets that are falling as the Fed talks about tapering QE. If investors were unwilling or unable to buy Chinese shares in the first place, they might have put relatively few assets in China following the flood of cheap stuff pumped out by QE.

H-shares (HSCE), Chinese stocks listed in Hong Kong, will lose relatively little with the tapering of QE because the local currency is pegged to the U.S. dollar, notes Lorraine Tan, equity researcher with S&P Capital IQ. The greenback tends to grow when high-yield markets fall. Absent some other source of counter-pressure, currencies elsewhere in Asia will depreciate with the easing of U.S. stimulus.

Chinese authorities are likely to gloat about the immunity of their markets, as independence from foreign forces -- economic as well as political -- always give the nationalistic government something to brag about. Stability of China's markets in a time of global decline or volatility would also support Beijing's policies of restricted market access.

"China's A-share market proved rather resilient to the (Fed) cut's impact with only slight fluctuations thanks to recent support measures and active growth stocks," the official Xinhua News Agency said on Aug. 21, referring to reports that the Fed would tighten its stimulus-linked $85 billion monthly bond-buying program.

"Emerging markets in Asia have responded with sinking stocks to the predicted U.S. stimulus cut, but a 1997-like Asian financial crisis is unlikely and China is expected to remain resilient against the impact," the Xinhua report adds.

According to minutes from a Federal Open Market Committee meeting, Fed officials favor tapering economic stimulus as long as U.S. data improve, signs the world's largest economy may be on the way out of whatever has sickened it since 2008. The Fed will probably "moderate" the pace of securities purchases later this year, according to a UBS research note.

Nervousness about a tightening of the U.S. bond-buying program pushed Indonesia's stock market 3.2% lower and Thailand's nearly 2% lower last week because both depend on cheap dollars to finance account deficits. Japan's Nikkei index fell 2.6%.

China's A-share market had slid 14% this year as of July 26 but recovered about a fifth of that loss as of Aug. 23. H-shares had fallen 22% this year by June 25 and then repaired a third of the damage by the end of last week.

Investors still suspect the A-share market of poor transparency, spotty regulations and bad deals for minority shareholders, so I won't sit here and pick stocks. I know of some weary asset managers who make a living doing that. They're cynical people.

To invest, look at the big offshore names getting QFII awards. BlackRock received a QFII allocation of $100 million in March. Going back to the QFII policy's earliest days, Citigroup and Morgan Stanley have been allowed to trade Chinese shares for the past decade, meaning they probably know a few things about which shares to pick.

Watch for more household names to receive QFII status or increase their quotas as China said in July it would increase the overall QFII quota from $80 billion to $150 billion, a short-term liquidity boost for A-shares.

Which leads me to another point: China isn't sitting back to gloat as tapering QE's impacts upon miss its markets. Railway financing reform and support for broadband development have lifted shares in "growth" sectors such as transportation and information, the national news agency says.

The agency further links the fate of China's markets to the slow state-driven shift from an economy reliant on exports and investment to one focused on domestic consumption.

Finally, for now, the central bank has about-faced after stunning markets in June by refusing to inject liquidity to ease interbank lending.

"Although the U.S. stimulus tapering will pose many challenges, China has the capability to withstand any financial crisis with stable economic growth and progressive restructuring," Xinhua says. I see no reason to doubt this forecast as long as the government keeps taking deliberate pro-market action.

At the time of publication the author had no position in any of the stocks mentioned.

Ralph Jennings is on LinkedIn.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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