Chinese stocks suffer 'healthy correction'

Shareholders on a security trading floor in Shenyang, China.
Getty Images
Shareholders on a security trading floor in Shenyang, China.

China's once-sizzling stock market entered correction territory as its 2 percent-plus slump on Friday left it more than 10 percent down from its early June peak, but strategists were sanguine on the market's longer-term outlook.

"After rising 140 percent over 12 months and around 50 percent year to date such volatility is to be expected as it has risen a bit too far too fast," said Shane Oliver, head of Investment Strategy and Chief Economist at AMP Capital.

Based on intra-day trading on Friday, the Shanghai Composite had slid as much 10.7 percent since June 12, when the benchmark index hit a seven-year high of 5,166.35.

"The easy gains are probably over and a period of correction would be healthy," Oliver said.

Despite the recent downturn, catalysts for further gains remain in place, say market watchers. Oliver cites the potential for further monetary easing as well as valuations as potential drivers.

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"It's worth reiterating that the Shanghai composite index on an historic PE of 21 times is still below its long term average and should benefit as further monetary easing comes through," he said.

"The latest share market correction means that it wouldn't be surprising to see another PBOC rate cut or required reserve ratio reduction soon," he said.

The ongoing trend of Chinese households reallocating their assets - away from real estate and wealth management products and into equities – will also help sustain the rally in the medium term, said Ben Bei, an analyst at CIMB.

"We project another Rmb4 trillion to flow into the equity market for the rest of the year, possibly lifting A-share float market cap by 40 percent," Bei wrote in a note on Thursday. "The key risks to our projection are 1) a change in monetary stance, and 2) a substantial property price rebound," he said.

What bubble? China stocks remain on an uptrend: Pro
What bubble? China stocks remain on an uptrend: Pro   

While Bei sees further upside to the A-share market, he advises investors to monitor possible "peaking signals."

"We do not think any individual fundamental or technical indicator can be used to conclude where the market is heading," Bei said.

"But the experience during the 2006-07 cycle suggests that the following indicators may be worth looking at: 1) divergence of market turnover and index, 2) divergence of index and majority stocks, 3) index return mostly contributed by large sectors such as financials and energy."