Bubbles and Bull Markets - Morphic Asset Management


Despite what seems in Australia to be all “doom and gloom” about China and it’s overbuilt of property which is seemingly manifested through falling iron ore prices (though we would argue the Iron Ore market is symptomatic of excess supply – and particularly lower cost increased supply which shifts the Marginal Cost breakeven point downwards), the Chinese stock market has been on a tear this year, with the main Market (Shanghai composite) up 40% YTD. Most commenters did not see this coming, as generally Emerging Markets have done poorly this year, with the tracker fund (EEM US) down 5% YTD.

So what explains this? We think it can probably be put down to a confluence of events, rather than a single one:

  • The most recent cause would appear to the cut in Interest rates on the 22nd of November, which has seen the market rally 16% since then. Whilst some of the more bearish commentators see it as “an act of desperation” (which it may well be in the long term), in the short term, history says the PBOC has tended to cut more than once.
  • But the backdrop was the market was rallying before this event. One point is that the Chinese market had become quite cheap. As per the chart below, the Market P/E had fallen to 8x Forward earnings earlier this year. We know the best single indicator of future performance is how much you pay for your asset.


Source: Bloomberg, Team Analysis

  • The issue is that stocks need a catalyst – most Emerging Markets are cheap currently – the interest rate cut proved to be the catalyst that got it going this time. China also benefits from a closed capital account so the rising USD isn’t affecting them like other Emerging Markets.
  • Further, in the background the ongoing crackdown on corruption that has driven sales of luxury goods down and reduced gambling in Macau, would appear to have found a new outlet. Like everything in China, the numbers are huge. The volumes traded on the Stock Exchange last week exceeded those of the New York Stock Exchange, which has been around 100 years longer and is a much larger portion of global markets.
  • Lastly, relating to volume – the amount of online trading accounts has mushroomed as 3G and 4G phones has increased access to data.
  • Like everything in life, it’s obvious in hindsight. The question is, where to from here? Most offshore investors aren’t participating in the rally, being disbelievers. So there are more people who can join. There is also the point that the markets aren’t expensive yet (though bears will point out the quality of earnings is poor). So the most likely path for next year is to continue upwards, with increasing volatility. Issues will arise later in the year as the US Federal Reserve begins tightening rates.

Morphic is long a few positions in the space, such as Shenzhen Expressway and Zhejiang Expressway with the latter being in the process of spinning off its stock brokerage business, (which we think in this market which is seeing rising volumes at brokerage houses, driving their earnings) will attract a lot of interest. We have not as yet built what we would call a large overweight (as per India) though.

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