In the US, it seems downright unpatriotic these days to suggest that the Chinese financial system might be sound and that good value is to be found in Chinese equities.

Bill Ackman

The Chinese financial system looks worse than the US in 2007, said Bill Ackman, head honcho at the giant Pershing Square hedge fund, last week in New York. He’s not just wrong; he’s dead wrong.

Let’s look at three issues to fully understand China’s stock market:

1) Economic and credit fundamentals;

2) Monetary policy, in particular China’s decision to keep the yuan pegged to the US dollar while the dollar jumped by 25% between June 2014 and March 2015; and

3) Regulatory issues, in particular the failure of Chinese authorities to control levered purchase of equities.

Chinese corporations and households are renowned for being big savers. Over the past 15 years, they’ve saved at an extremely high rate, while the American personal savings rate fell to zero during the last decade’s bubble years. So, not only is corporate and household leverage much lower in China now than it was in the US in 2007, it’s lower than the US today.

The 1,114 companies listed in the Shanghai Composite Index have a Net Debt-to-EBITDA ratio of less than 50%, according to World Development Indicators. Compare that with 170% for the S&P 1500 Index, which was as high as 250% in 2007. Chinese companies have about twice as much cash relative to total liabilities as their American counterparts.

And unlike in the US, where you could buy a house with no money down, leverage remains low in the Chinese mortgage market, which requires down payments of at least 30% the cost.

Meanwhile, the Chinese government’s decision to keep the yuan linked to the dollar has had ripple effects throughout the economy. As the dollar’s value appreciates, so does the yuan’s. This has affected export growth negatively. As the People’s Bank of China held close to the dollar during the stock rout, it only hurt exporters more, creating a drag on growth.

And while the government is continuing to pump up the market, buy-side buyers in Hong Kong are beginning to believe that China’s economy is bottoming out. The housing market has been recovering and the One Belt One Road project leads many to believe the government will soon be spending a lot on infrastructure. Finally, retail sales in China grew to 10.6% year over year from 10.2% in May.

In the end, Asia Unhedged remains bullish on the Chinese economy and continues to find good value in Chinese equities, especially the H-Shares. They currently trade at 8.54 times the Hang Seng China Enterprises Index.

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