China index futures give belated lift to market

By Lu Jianxin and Edmund Klamann – Analysis

SHANGHAI (BestGrowthStock) – China’s stock market bulls have waited a long time for a boost from the country’s plans to launch stock index futures, and the pay-off is finally at hand.

The launch of futures trading on Friday is tugging investor attention toward large-cap stocks, whose valuations have lagged, helping to nudge the long-wavering stock market into a bullish trend for this quarter.

“Institutions have been buying more large caps this week, conducting a rehearsal for index futures trading. That indicates the index should have more room to rise,” said Chen Huiqin, senior stock analyst at Huatai Securities in Nanjing.

Futures will be based on the CSI300 index of the most actively traded and highly capitalized shares on the Shanghai and Shenzhen markets, instead of the broad-based Shanghai Composite Index, the current mainland benchmark.

This will make market heavyweights a stronger magnet for investor interest, which now often gravitates toward speculation in small-cap shares that are favorites with retail investors.

Many market watchers had expected a large cap-driven rally when the index futures plan was announced in January, but an official clampdown on booming bank loans ended up putting a damper on the market and spurring worries over an earlier-than-expected exit from China’s economic stimulus.

New bank lending has now been reined in, however, with March data announced on Monday coming in much lower than expected, suggesting that the Beijing authorities have achieved their goal and can take their time in considering harsher monetary policy tightening such as raising interest rates.

That should help the Shanghai Composite Index establish firm support at its 125-day moving average, a key chart line used in the Chinese market to delineate bullish and bearish territory and which offered stiff resistance until it was breached late in the first quarter.

“Historically speaking, around the world the launch of index futures has typically heralded a bullish rather than bearish stock run,” said Tan Wentao, head of research at HNA Futures in Shanghai.

The composite index spent most of the first quarter between 2,950 and 3,100 points, below its 125-day average which now stands at 3,125 points, as fears over an imminent normalization of China’s ultra-easy monetary policy offset the upbeat outlook for the strongly recovering economy and corporate earnings.

But the index began showing signs of life in late March, rising decisively above the 125-day average for the first time in two months as institutional investors tested the waters with purchases of selected large caps.

The index has since convincingly broken free of that technical barrier and on Thursday rose to its highest intraday level in three months at 3,181.663 points.

FUTURE BENCHMARK

Analysts expect the index to move mainly in a higher 3,150 to 3,350 point range in the second quarter, paving the way for a rally in the second half of the year.

“The economic trend is seen steadily improving this year, fuelling strong gains in corporate earnings, so the index should see a slow bull move heading for 3,500 points in late 2010,” said Zheng Weigang, head of investment at Shanghai Securities.

The key to a blue chip-driven rally, however, will be their relatively modest valuations, analysts said.

“The valuations of large caps, particularly banking stocks, have lagged far behind the overall market,” said Cao Xuefeng, senior analyst at Western Securities in Chengdu.

He noted that the authorities’ clampdown on liquidity earlier this year capped the supply of funds available to investors to trade large-cap shares.

Components of the CSI300 Index , which covers the 300 largest firms by daily turnover and market capitalization on the Shanghai and Shenzhen stock exchanges, now have a forward price earnings (PE) ratio of 15 times forecast 2010 earnings, compared with a Shanghai market average of 23 times.

The CSI300, which accounts for 60 percent of the markets’ combined $3.7 trillion capitalization, will likely be quickly elevated to replace the Shanghai Composite as the Chinese market benchmark, in line with a global trend of using blue-chip indexes, as index futures boost turnover in index heavyweights.

“The index futures are expected to lead to a fundamental change in the Chinese market. Trading will no longer focus on small caps as it does now on many days,” said Huitai’s Chen.

Money

(Editing by Alex Richardson)

($1=6.83 Yuan)

China index futures give belated lift to market