China's wild market swings: This is just the start

China stocks having a 'healthy correction': Pro
China stocks having a 'healthy correction': Pro   

The rout in China stocks on Tuesday is a healthy bull-market correction, say strategists, however the wild swings reinforce that the market is not for the faint of heart.

The benchmark Shanghai Composite lived up to its notoriously volatile reputation on Wednesday, swinging between gains and losses after the market tanked more than 5 percent a day earlier – its biggest single-day percentage fall in 5 years.

Losses were triggered by the Chinese securities clearing house's decision late Monday to restrict the use of lower-grade corporate debt as collateral for short-term loans obtained through repurchase agreements. The move follows a surge in margin buying that accompanied the recent stock surge.

Strategists, however, don't believe the latest regulatory move will derail broader momentum in the market that has rallied 35.5 percent year to date.

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"The new regulations were more of a negative catalyst for profit-taking. We see Tuesday's selloff as a healthy correction," said Stephen Sheung, head of investment strategy at SHK Private.

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Sheung says a reduction in leverage is unlikely to have a large impact because on the stock market: "You only need a small amount of money to move from bank deposits or wealth management products into stocks to push the market higher."

Audrey Goh, equity strategist at Standard Chartered also sees the recent market plunge as a pause for breath.

"Yesterday's move was a reaction to the rapid appreciation in the market over the past month," Goh said.

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"Sentiment wise, there may be a perception that regulators are tightening up policies. But I think they are going on the right track because historically collateral has not been tightly scrutinized - this is all part of the reform process and shouldn't have a long-term impact on the market," she added.

Market drivers in tact

The drivers behind the market's recent gains remain intact, say analysts, pointing to its low valuations compared with regional peers.

The Shanghai Composite is trading at a price to earnings ratio of 12.2, well below 19.9 for Japan's Nikkei 225 and 14.5 for Taiwan's Taiex.

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Furthermore, the government has exhibited a more pro-active policy stance in recent months - a positive for stocks.

"Government initiatives to stabilize growth through cutting rates and targeted easing measures, for example, tell us Chinese authorities want to protect the baseline growth rate at 6.5-7 percent," said Goh.

Stomaching volatility

While there may be more upside in store, strategists say gains will surely be accompanied by more volatility.

The primary reason is because of the large participation by retail investors, who tend to be more fickle-minded.

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"The best reference point for the A-share market is 2006-2007, when the market went from 1000 to 6000 in the span of 20 months. Corrections during this period normally lasted 2-3 weeks, and were in the magnitude of 10-20 percent," Sheung said.

"If investors can't bear the downside of 10-20 percent, which is a normal correction for the stock market, it might not be the right investment for them," he added.

For investors willing to brace market swings, Sheung says there could be double-digit returns in store next year as well.

He sees the Shanghai Composite rising as high as 3,520 by end 2015, a 23 percent rise from current levels.