MNI ANALYSIS: Chinext Rally Points To Mainland Equity Bottom

--Equity Rally Seen As Prerequisite To Yuan Recovery

By Stuart Allsopp

     SINGAPORE (MNI) - China stocks may very well have bottomed out back on

October 19 when the 'National Team' announced a series of measures aimed at

supporting stock markets. Tuesday's break higher in the tech-heavy Chinext,

which has overcome its 55-day moving average to trade at a six-week high, adds

weight to the bullish case.

     While downside pressure in U.S. stocks, which look like they are tracing

out a major topping pattern, still pose risks for Chinese stocks, on a relative

basis Chinese outperformance is looking highly likely. Today's positive reaction

to headlines from the South China Morning Post regarding a top Chinese trade

envoy travelling to the U.S. has seen a higher low establish itself in mainland

indices.

     The combination of bearish sentiment and an improving technical picture is

further backed up by the extreme valuation discount relative to both historical

averages and the U.S. The CSI300 trades near all-time low valuations, with a

price-to-book ratio of 1.5x, less than half of that seen on Wall St.

     --PBOC SHIFT NEEDED

     A rally in Chinese stocks is likely a necessary condition for a recovery in

the yuan, as USDCNH has moved higher hand in hand with the ratio of U.S. over

Chinese stocks over recent months. However, a more sustainable rally in the yuan

will require a narrowing in the current large differential in China-U.S.

monetary policy stances.

     Given the ongoing tightening of U.S. financial conditions, a recovery in

risk appetite itself is unlikely to be enough to sustain a yuan rally. Chinese

interest rate swaps were actually down on the day Tuesday, despite the rally in

stocks, highlighting the PBOC's relatively dovish stance, which is keeping

U.S.-China yield spreads near multi-year highs.

     Key to a sustainable yuan rally will be whether the PBOC notably shifts its

policy stance. In an interview with MNI published Monday, PBOC advisor Ma Jun

noted that Chinese authorities have switched to stabilising the economy's

leverage levels, rather than pursuing a rapid decrease in debt ratios, something

which has long been priced into rate markets. A positive breakthrough on trade

relations with the US would need to be backed up by a hawkish shift in order to

allow a sustainable reversal in USDCNH.

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