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Global Top Cat

Decoding the Spike in SHIBOR

By Yiannis G. Mostrous, on Jul. 19, 2013

Disappointing economic data and turbulence in the overnight Shanghai Interbank Offered Rate (SHIBOR) market have weighed on the CSI 300, which comprises 300 equities listed on the Shanghai or Shenzhen Stock Exchanges.

The overnight SHIBOR surged to a record high of 13.4 percent on June 20, when the People’s Bank of China (PBOC)–the nation’s central bank–refrained from injecting additional liquidity into the system in an effort to quell riskier, shadow lending. Having fired this warning shot, the PBOC in subsequent weeks hasn’t issued any repos or bills–moves that would remove liquidity from the market–enabling the rate to recede.

Source: Bloomberg

Many market pundits questioned the wisdom of allowing the overnight SHIBOR to spike and the central bank’s ability to calm the interbank lending market. Although worries about heightened systemic risk in China’s financial system appear legitimate, the PBOC made its point loud and clear: Aggressive lenders will be scrutinized and severely penalized. Small and midsize banks in particular have taken on excessive concentrations of high-risk assets, betting that the PBOC will bail the system out if things go wrong.

With the PBOC committed to tightening and reining in speculation, investors should look for the long-awaited process of capacity adjustment to get under way. That is, as capital allocation becomes more rational, consolidation will occur in crowded industries such as steel and cement production, boosting profits and growth opportunities for the larger survivors. However, this longer-term trend will bring its fair share of pain to the stock market.

Shortsighted criticisms aside, the PBOC delivered a stern warning to the financial system to stop lending to speculative ventures and to rely less on interbank funding. More important, this gesture didn’t spark a bank run or affecting the real economy

As the SHIBOR market stabilized, China’s stock market rebounded from its low in late June. We wouldn’t be surprised if the CSI 300 recovers to the levels that prevailed in early June; valuations appear undemanding, and investors are becoming more comfortable with the PBOC’s ability to prevent a major financial conflagration.

Any additional upside will depend on the performance of the Chinese economy in the second half of the year. To that end, we expect the Mainland economy to fare better in the final six months of the year, driven by improvements in real estate, exports and domestic consumption.

As long as China grows its gross domestic product by at least 6 percent, this slowdown shouldn’t present any major issues for the global economy. In fact, slower growth in China should help to keep commodity prices and inflation in check. And relatively low levels of inflation enable central banks to extend accommodative policies–always a positive for equity markets.

We will continue to monitor real-estate sales trends in China. Households regard property ownership as a means of preserving wealth; the housing market provides a good barometer of economic strength. And improvements in the US and Japan’s economies bode well for export growth in the back half of the year.

Patient investors with a longer time horizon should consider scooping up Chinese equities from the following industries: real estate, consumer staples and information technology. Bank stocks also trade at favorable valuations, but investors need to tread careful and be selective. 

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