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China's markets have had an incredibly strong summer — but troubles loom

  • The Shanghai Composite rose 3 percent in August, pushing the index's gains to more than 8 percent in 2017
  • China's yuan just recorded its strongest month in 2017, appreciating 2 percent against the U.S. dollar
  • China's stock markets have been buoyed by strong performance in the financial sector, with the biggest four state-owned banks capping August with decent earnings

China's markets sizzled this summer, but experts say numerous risks loom — so keep the champagne on ice.

The Shanghai Composite rose 3 percent in August, extending July's rise and pushing the benchmark index's gains to more than 8 percent in 2017. Similarly, China's yuan recorded its strongest month in 2017, appreciating 2 percent against the U.S. dollar as the currency accelerated to 5 percent year-to-date.

The security trading floor in Shenyang, Liaoning province of China
Getty Images
The security trading floor in Shenyang, Liaoning province of China

Experts have attributed the boost in Chinese markets to better-than-expected growth in the world's second-largest economy. Stronger growth has been largely due to Beijing's meddling in the markets and economy to prevent embarrassing swings ahead of a major leadership transition in the fall, experts say — but that playbook can't be sustained.

"While state buying can support equities in the short term, over the medium term, the government's interventionist mindset won't help the market," said Chang Liu, China economist with Capital Economics.

"With valuations no longer cheap, we believe the upside for A-shares is limited," he added, using a term to describe stocks traded in the mainland.

China's stock markets have also been buoyed by strong performance in the financial sector, with the biggest four state-owned banks capping August with decent earnings. All of them — Industrial and Commercial Bank of China, Bank of China, China Construction Bank and Agricultural Bank of China — reported faster profit growth for the first half of the year.

ICBC, the world's largest bank by assets, saw net profit rise 1.8 percent to 153 billion yuan, versus a 0.4 percent growth in 2016. Bank of China posted the biggest boost, with net profit spiking 11.5 percent to 104 billion yuan, versus a 1.9 percent increase last year.

Net interest income rose at the banks, led by a 7.1 percent rise at ICBC to 251 billion yuan. Asset quality also improved with non-performing loan ratios largely ticking down, apart from at China Construction Bank, where they were flat.

Beijing has been cracking down to reduce risks to China's financial system, and has even gone so far as to order financial institutions to make recordings of investment product sales to further regulate markets and defend against compensation demands if investments tank. Nomura analysts say the regulatory-driven deleveraging has boosted performance at the country's largest banks.

But experts are worried about how government policies and actions might shift after a twice-a-decade political power changeover at China's 19th Party Congress. Changes could hit the all-important financial sector, the world's second-largest economy and its markets.

"We expect sort of a very short and shallow recovery for the banks," said Matthew Phan, a senior banks analyst at CreditSights. "We think that with the slowing credit growth, we might start to see the economic slowdown again next year, especially after the Party Congress."