A buying frenzy of China's biggest publicly traded companies has sent a gauge tracking such large-cap stocks close to a 12-year high as traders take positions in the only major global economy that is showing signs of a recovery from the coronavirus pandemic.
The SSE 50 Index, which tracks the 50 most valuable companies on the Shanghai Stock Exchange, advanced by as much as 0.4 per cent to an intraday high of 3,568.72, a level not seen since February 2008 before the Global Financial Crisis. It dropped 0.2 per cent to 3,545.34 at the close on Wednesday.
Ping An Insurance, Kweichow Moutai and China Merchants Banks carry the three heaviest weightings on the SSE 50, which is dominated by companies whose earnings growth are most tied to the strength of the Chinese economy.
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The shift among traders to bigger companies engaged in traditional industries has been in full swing over the past few months, as the latest statistical data signals that China's economic recovery is sustainable and positive developments in possible Covid-19 vaccines brighten the outlook of global growth. The playbook is in line with what has been happening in other major equity markets such as New York and Hong Kong, where traders have piled into cyclical stocks and pulled out of the technology companies that were the biggest beneficiaries of working from home.
"There's a consensus about the economic recovery and the expectations are good about the economy in the first half of next year," said Ma Wenyu, an analyst at Shanxi Securities. "Earnings for cyclical companies should be guaranteed and the rotational buying will be continuing."
Big companies and cyclical stocks also offer more safety than small-cap equities, whose elevated valuations have made them very vulnerable to even slightly negative news, according to Ma, who recommends investors put money in financials and coal producers.
The SSE 50 is valued at 14.9 times prospective earnings, even after the recent run-up. That is a fraction of the earnings multiple for the technology-heavy Star Market, at 93.9 times, and cheaper than the ChiNext board for start-ups at 61.3 times.
The rally on smaller companies has also stalled on concern that China's economic recovery will prompt the Chinese central bank to scale back its loose monetary policy. Such a tightening in monetary policy could derail the liquidity-driven run-up on small-caps, brokers said. The latest quarterly monetary policy report by the People's Bank of China showed that interest rates were trending higher, which is seen as a catalyst for improving financial outlook particularly for banks that rely on the margin between their lending and deposit rates as profit.
"The pro-cycle [trading strategy] is expected to continue being the major theme of the stock market amid China's sustained recovery and the imminent arrival of the vaccines," said Chen Guo, an analyst at Essence Securities.
A purchasing managers' index showed that China's manufacturing industry expanded for a ninth consecutive month in November, while profits for the nation's biggest industrial companies rose 28 per cent in October at the fastest pace in nine years.
"Before economic growth peaks, such rotational buying [of cyclical stocks] is hard to be reversed," said Zeng Wanping, an analyst at China Galaxy Securities.