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BofA: The Shanghai Composite Will Plummet by Nearly 30 Percent in 2016

BofA: The Shanghai Composite Will Plummet by Nearly 30 Percent in 2016
(Dollar Photo Club)

By    |   Tuesday, 05 January 2016 09:38 AM

The early January blues for Chinese stocks will persist throughout 2016, according to Bank of America Merrill Lynch, which expects the Shanghai Composite index to end the year down roughly 27 percent at about 2,600.

David Cui, head of China equity strategy, is known to be bearish on the world's second-largest economy — which is to say that he's less sanguine than most of his peers about the consequences of unwinding leverage that's quickly mounted in a short period of time.

For China — which has enjoyed a rapid expansion of debt relative to the size of its economy — this time will not be different, Cui contends.

"Historically, any country that grew debt this fast inevitably ran into financial system problems, including currency devaluation, banking recap, and high inflation, and we do not expect China to be an exception," asserts Cui. "We believe that the government had maintained system stability over the past few years by allowing various implicit guarantees to get firmly entrenched, which has made the financial system fragile."

The fragile equilibrium that has endured, he says, is a function of Chinese policymakers' willingness to trade short- term gain for longer-term pain.

(Of note: Cui's call doesn't include a full-scale credit crunch — the disappearance of what's increasingly become the lifeblood of the Chinese economy — as a prerequisite for the prophesied carnage in equities.)

The A-shares market, according to Cui, is expensive — and if you strip out banks (for which the quality and sustainability of earnings may be in jeopardy in light of a deteriorating loan book), it only gets pricier.

It's clear, however, that there are innumerate countervailing forces that would support the market and work against the strategist's call for further declines: liquidity from the People's Bank of China provided through reverse- repurchase operations, restricting larger owners from divesting their holdings, direct purchases of equities by government funds, and a distinct distaste for allowing defaults.

However, Cui believes that a failure of any of the major conditions that investors are counting on the government to provide to better the market backdrop (namely, reaching the GDP growth target, maintaining stability in the currency, a PBoC put in A-shares, limited corporate defaults, and the evasion of a sizeable real estate correction) would be the proximate cause of instability in the financial system.

"We believe that the most vulnerable is [the renminbi], followed by A-share market, debt default and possibly housing price," writes Cui. "Any break of these 'promises' may be contagious."

BofAML's David Woo has separately detailed how this year will be one marked by a "Great Divorce" between the U.S. and China, which will be reflected in the exchange rate.

Nailing the inflection point in the world's second-largest economy, given the bevy of attention paid to Chinese economic imbalances since the financial crisis and the relative flexibility enjoyed by policymakers to remedy any short-term concerns, will surely prove to be difficult.

But in the strategist's opinion, the irreconcilable goals of Beijing's brain trust "may come to a head in 2016."

After this week's fall in Chinese stocks, there's only 21 percent more of downside to go!


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The early January blues for Chinese stocks will persist throughout 2016, according to Bank of America Merrill Lynch, which expects the Shanghai Composite index to end the year down roughly 27 percent at about 2,600.
BofA, china, Shanghai Composite, stock market
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2016-38-05
Tuesday, 05 January 2016 09:38 AM
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