China Money Week: Bear Trap Or Market Bottom?

Equity Bounce More Sustainable Than Yuan Rally

By Stuart Allsopp

     SINGAPORE (MNI) - Chinese assets have surged today toping off an impressive

week as hopes of a trade deal between the world's top two economies have been

raised by news that President Trump has asked his cabinet to propose a potential

deal with China. USDCNH has cleanly broken its uptrend while the CSI300 has

recovered the 3300 level, triggering technical buy signals in both assets.

     Trade headlines are likely to continue driving markets in the near term

amid the high and rising rolling correlation between the currency and equities.

But, equities likely have a much stronger chance of outperforming than the yuan

given the extreme valuation discount supporting stocks and the ongoing rise in

US real interest rates acting against the yuan.

     EQUITY OUTPEROFRMNACE HIGHLY LIKELY...

     While Chinese stocks are trading near record-low valuations, internal

market strength has been improving for several weeks, reflected by the

divergence between the number of individual stocks hitting new lows relative to

the broader indices. Such a combination of factors has historically been

bullish, and given the market has China's National Team at its back, upside

potential outweighs downside risks. On a relative basis Chinese stocks are

particularly attractive given that US stocks remain near their most overvalued

levels ever on cyclically-adjusted valuation ratios.

     ...SUSTAINED YUAN GAINS REQUIRE SHIFT IN PBOC STANCE

     The outlook for the yuan is less positive given the ongoing widening of

US-China nominal and real yield spreads. While there is certainly room for

further downside in USDCNH in the near term as risk appetite returns, relative

monetary policy conditions between the two countries continue to diverge. It

would likely take a sizeable rally in stocks to trigger a rise in interest rate

swaps sufficient to justify sustainable yuan gains. In contrast, should stocks

fail to rally, yield spreads would likely continue to move even further against

the yuan.

--MNI London Bureau; +44-203-865-3820; email: Ian.Stannard@marketnews.com

--MNI Singapore Bureau; +65 8233 2326; email: Asia-Editor@marketnews.com