On the financial front, 2006 has been a pretty good year all around. Stock markets in many countries have rallied, energy prices have fallen, inflation is relatively low and growth in GDP ranges from respectable to robust. But the economies of most countries also face a number of threats — some predictable, some not — that could derail recent progress. What’s ahead for 2007 in the U.S., India, Europe, Latin America, China and other parts of the world?
Spain and Europe: Banking on Continued Growth
The Spanish stock market has enjoyed four consecutive years of significant price gains. But will the market continue to spread joy next year? Although experts have no crystal ball that enables them to make an infallible prediction, most analysts consulted by Expansión, the Spanish business daily, are placing their bets on a fifth straight year of rising prices, during which the Ibex 35 could rise by about 10%.
Altina Sebastián González, professor of finance at the Complutense University of Madrid, is optimistic about the behavior of the Spanish index. In her opinion, in 2007 the Ibex 35 could rise to about 15,500 points, compared with its current level of about 14,000 points. This prediction, she says, “is based on an economy that is still growing and will continue to do so in the coming year, and on an inflation rate that shows signs of slowing down despite its dependence on oil prices.” Foreign demand “will continue to be vigorous,” she adds, “thanks to growth in the euro zone and in the economies of Latin America. All of these factors create a landscape where business profits will continue to behave in a positive way.”
Sebastián also believes that the current wave of takeovers, initial public offerings and mergers will continue in 2007, along with the creation of large risk capital funds that are eager to make investments.
Yet Sergio R. Torassa, a finance professor at the European University, believes that “at the beginning of the new year, we may witness a technical correction of some intensity as a result of the distortions created by the change in the tax regulations that will go into effect starting on January 1, 2007. Many investors are delaying their buying decisions until after that date because [short-term] capital gains on investments covering a period of less than one year will be subject to significantly better treatment starting in January.”
Looking at the various sectors, he adds, “It is possible that shares of bank and insurance stocks will outperform the market, as well as telecommunications companies. Rising interest rates will help banks and insurance companies, along with rising demand for credit stemming from GDP growth and a low level of late payments [by borrowers].” Regarding telecommunications companies, he explains, “Their low price/earnings rations and the attractiveness of their dividends will draw attention from investors.”
Sebastián and Torassa don’t agree with those experts who argue that the real estate sector has no further upside. Both experts believe that the big Spanish construction firms have learned how to globalize and diversify their business activity. They have converted themselves into service-oriented conglomerates, as demonstrated by their investments in electric utilities and in companies that manage infrastructure. “It would be a mistake to evaluate the shares of these companies as if they were merely construction firms,” Sebastián says.
When it comes to European stock exchanges, the experts are quite confident about prospects for 2007. Spain lagged behind in 2006, but it is quite possible that the situation will be different next year. Analysts at Banif, a private-bank subsidiary of Banco Santander, note that “European stock prices [outside Spain] are either cheap or properly valued, while stocks in Spain are either properly valued or are expensive.”
For the last two years, notes Sebastián, European stock markets have been behaving very well, with average price rises in the double digits. Nevertheless, she says, “this excellent performance has nothing to do with any risk of over-valuation because price-earnings ratios [in Europe] are far below the levels that were associated with stock prices back in 2000. On the contrary, the markets continue to show multipliers that are more than just reasonable. With the Ibex at historic heights, the price earnings ratio of the Spanish stock exchange is 15.75. When it comes to European shares, the multipliers are even lower — 12.58 for the Eurostoxx and 12.45 for the FTSE 100.”
Looking at these multiples, and projecting growth in corporate profits, it seems that there is still some room for European stock prices to rise higher. “The data about the economic situation,” Sebastian says, “point in this direction: The latest forecasts of the European Central Bank are optimistic; for 2007 and 2008, they project higher economic growth and lower inflation than in the previous forecasts.”
Nevertheless, says Torassa, “In recent years, Spanish companies have demonstrated an extraordinary ability to increase their profits. So far this year, those companies that comprise the Ibex [index] have earned almost 29.6 billion euros, or 33% more than they earned during the same period in 2005. Over the last three years, their profits have doubled, rising from 15.1 billion euros in 2003. The Ibex [index] itself rose by 94% from the middle of November 2003 to the mid-November 2006. Although interest rates have increased by 1.25% in 2006, this sharp rise in the cost of financing has not interfered with the growth rate of business profits. If these trends continue, we could see a new fiscal year in which shares of Spanish companies outperform their counterparts elsewhere in Europe.”
Both experts agree that Spanish companies benefit from another advantage: Their strategy of geographic diversification has put them in a favorable position when it comes to dealing with any slowdown in local [Spanish] markets. “Latin America brings them higher and higher rates of activity and profits. Their recent investments in Asia — such as those made by Telefónica and BBVA — provide these companies with access to markets that have millions of potential consumers,” notes Torassa.
However, not everything that glitters is gold. There are areas of concern that the Spanish economy must address. These include the rigidity of labor markets, the taxation system, and low productivity. “Spain heads the list of EU-15 countries where it is hardest to dismiss workers, and Spain occupies third place (after only France and Greece) when it comes to countries where it is hardest to hire people,” Torassa notes. The high level of taxation, he says, “not only has social costs but also provides a disincentive for business activity. It also contributes to fraud. Finally, there is a significant productivity gap between the United States and the European Union, and the differential with Spain is even greater.”
Sebastián cites several reasons why there will not be any relaxation in the frenetic pace of mergers and acquisitions in Spain in 2007:
- The globalization of markets demands that companies make a significant effort to become more international.
- The creation of a single European market has yet to be fully achieved. Although some nationalistic barriers continue to exist, the logic of the marketplace and pressure from the European Union are acting as catalysts for new corporate deals, both domestic and across borders.
- In recent years, Spanish companies have made a major effort to improve their management, and their efforts have “had tangible results,” says Sebastian.
- The growth strategy adopted by Spanish companies has been supported by corporate policy that views acquisitions as a means for achieving operational synergies based on economies of scale and/or increased revenues.
The outlook for the U.S
In the U.S., the outlook for 2007 is generally good, according to a number of Wharton professors, although some worry about the falling housing market in the U.S. and a protectionist bias in the Democratic Congress. Then, too, an economic snag in China could ripple around the world. Moves to the political left could hamper growth in Latin America, while red tape could entangle progress in India, where stocks may be ready for a pullback.
In the U.S., “I see lower GDP growth, about 2.5%” for 2007, predicts finance professor Jeremy Siegel. GDP grew at an annualized rate of 5.6% in the first quarter of 2006, then fell to 2.6% in the second quarter and 2.2% in the third. “I look for the markets to be fairly good. I could see [U.S.] stocks up 10% next year. I think interest rates will stay stable — I don’t think the Fed is going to reduce rates very soon, probably not until the second half of the year. I think the dollar will be on the soft side, but I don’t see any big crash or anything like that.” Foreign stocks are also likely to do well, he says. That will be especially good for American investors as a falling dollar makes foreign holdings more valuable in dollar terms.
“I think the biggest positive for the stock market is low interest rates,” adds Siegel. “We have good emerging markets growth, decent European growth. Japan is sputtering right now but it’s not as bad as it used to be.”
While there are threats to this positive view, none look too serious, he says. With Democrats in control of Congress, there is the potential for tariffs and other protectionist measures, but the prospects do not seem very serious. Even raising the minimum wage would not threaten growth in the U.S., he suggests. Democrats are not likely to extend the Bush tax cuts enacted early in the decade, he adds, but this will not be a serious matter in 2007 because the cuts do not expire until the end of 2010.
The Housing Slump
“Overall, things are looking reasonably good for the near future,” agrees finance professor Richard Marston. Most economists, he says, put the prospects of a recession at about 30%, which is not alarming. The jump in energy prices in 2005 and early 2006 proved that this sector alone cannot cripple the economy the way it once could — and energy prices have since fallen.
But Marston is very concerned that the slump in the U.S. housing market could undermine consumer spending, causing real economic trouble. “I really think this is going to be a more prolonged decline than other people think,” he says, noting that after real estate prices dropped in 1989, it took many parts of the country until the mid-1990s to recover.
The housing sector is especially risky because of the mushrooming use in recent years of adjustable-rate mortgages and sub-prime loans, he adds. Many of the variable-rate loans issued in recent years are now adjusting to higher interest rates, causing borrowers’ monthly payments to soar. “What we’ve done is made our financial markets efficient enough to let families dig holes to bury themselves.”
Recessions often come in the wake of big gains in asset prices, Marston notes. The recession of 2001, for example, followed the big stock gains of the late 1990s. In recent years, the asset-price gains have been in housing. On the other hand, inflation does not appear to be a serious threat, he says, so the Federal Reserve may be able to cut short-term interest rates in 2007, helping stimulate the economy to offset damage from the housing sector.
Finance professor Franklin Allen also is concerned about threats from the housing sector. In recent years, much of the crucial growth in consumer spending has been fueled by money from mortgage refinancing made possible by soaring housing values. Now that housing prices are dropping in many parts of the country, fewer homeowners are likely to refinance, closing the spigot on this source of consumer spending. “The savings rate has been very low for a long time, and people say it’s because people have been making money on their assets,” he says. “The main asset is housing. If that reverses, it’s not a good sign.”
Despite this concern, Allen is generally optimistic about 2007. He thinks the dollar will continue to fall and interest rates and inflation could rise, but not enough to do serious damage.
Nor does he expect Washington to enact the kind of dramatic shift in economic policy that can roil the markets. “It will probably just go into gridlock, which is probably a good thing,” he says.
The 800-Pound Gorilla
The biggest issue for 2007 may be China’s economy and currency policy. Many U.S. politicians want China to let its currency, the Renminbi, or RMB, appreciate against the dollar. That would make Chinese goods more expensive to foreigners, allowing other countries to compete better with China’s low-cost producers. China has resisted any major appreciation of the RMB.
Management professor Marshall W. Meyer thinks the Chinese government will let the RMB strengthen, but only a “little bit” in the near future, and only when the issue is in the spotlight — during U.S. Treasury Secretary Henry Paulson’s visit to China this month, for example.
Marston suggests that China may eventually let the RMB rise further in response to international pressure, and he thinks “Paulson is the perfect person to get this view across.” Not only will this be good for other countries competing with China, it is likely to be good for the Chinese as well because it will reduce their incentive to plough surpluses into U.S. Treasury bonds. Instead of earning a poor 4.5% on Treasuries, the Chinese will invest at home, he predicts.
But he cautions that even if China were to let the RMB float freely, the results might be disappointing for the rest of the world. China would continue to be a tough competitor even if the RMB rose 30% or 40% against the dollar. “I think the Chinese economy is so competitive that it’s a little bit frightening in terms of what it has done to other countries in the world.”
Indeed, much of the current economic weakness in Mexico and other Latin American countries comes from their inability to compete with China, Marston says. “The Latin American economies are basically dead in the water.”
Yet as formidable as it is, the Chinese economy is not without problems — some severe enough to pose a potential threat to the rest of the world, according to Meyer. Capital markets are stalled on the mainland, with most Chinese companies raising money instead in the Hong Kong markets. As a result, Chinese people do not have many opportunities to invest for ordinary goals like paying for higher education or retirement. They settle for bank savings offering low returns.
And many Chinese banks are shaky, Meyer adds. Banks have not been modernized to the extent many other industries have. As a result, politics drive many loan-making decisions, and Chinese banks have lent enormous sums that may never be paid back. “The magnitude of non-performing loans may or may not be a lot greater than has been reported,” Meyer notes: “Whatever the number is, it’s not going down. It’s going up.”
In recent years, the government has allowed its citizens to move larger sums of money out of the country. In the worst case, that could cause worried people to take money out in search of safer investments, which, in turn, could cause a run on the banks similar to the ones that occurred in other Asian countries in the 1990s. The government then might resort to raising money by selling the enormous reserves it has placed in U.S. Treasury bonds, causing interest rates to soar in the U.S. and other countries. “I think the odds of this are not high,” Meyer says. But the odds may be growing because the banks have failed to get control of the bad loans, he adds. While the Chinese government is not in denial about this problem, it is not clear whether it will be able to act quickly enough in a crisis.
Elsewhere in the world, Allen worries that continuing problems in Iraq and the rest of the Middle East could create surprises that are more likely to be bad for the financial markets than good. India’s economy and financial markets have been developing impressively, Siegel says, but there is still much need for reform. Restrictive regulations have been relaxed somewhat, and it is now easier for new companies to get started. “But there still is a lot of red tape in India,” Siegel notes. Indian stocks have done very well, and prices are now high enough to be vulnerable to a pullback.
He also worries about Latin America, where a trend toward the political left could discourage needed investment. For Latin America, as well as the rest of the world, the bottom line is simple, Siegel says: “You have to be capital-friendly in today’s global economy.”
Capital Takes a Round Trip in Latin America
Hugo A. Macías Cardona, director of the CIECA research center at the University of Medellín in Colombia, tells this story about markets in Latin America: In the middle of 2006, he says, “Those Latin American workers who had deposited their savings in pension funds and unemployment funds – money they receive if they lose their jobs – or simply in trust funds that speculated in the stock market, saw their balances drop by a significant amount. It reached the point where they made massive withdrawals of their money from various institutions. Thus, these workers played a direct role in the speculative economy.”
Macías explains that external conditions now have an impact on this sort of crisis. “Five years ago, an unskilled worker could not imagine that a decision made by the Federal Reserve of the United States or by the board of the European Central Bank would affect his personal finances to such a degree, and so immediately. We live in a globalized economy, and this type of decision can affect everyone’s finances, and right away,” he says.
Macías notes that a great deal of capital moved into developing countries in search of higher levels of profitability because interest rates in Europe and especially in the U.S. were quite low at the start of 2005. As a result, [Latin American] stock markets rose by an average rate of 45% during 2005, and growth continued until the first week of May 2006.” But with the gradual increase in interest rates in these important regions, capital began to return home.
“Much of this money was invested in variable yield securities, which are high-risk but also provide high returns,” says Macías. In an effort to take advantage of opportunities in developed countries once more, “investors went to the market and sold their assets, even at low prices, which caused prices to drop even further. As a result, all those people who had invested their money lost significant sums. At least, their losses were smaller than the gains that their capital had earned during the previous year.”
In June 2006, the general index of the Colombian stock exchange (IGBC) suffered a decline of about 35%, most of which accumulated during the last three weeks of that month. For the first time since the three stock exchanges in the country merged, notes Macías, “trading was suspended because prices dropped by more than 10% in one day…leading to the highest level of uncertainty in the last fifteen years. The significant drop in the prices of shares and public sector bonds (known as the TES) was accompanied by withdrawals by a significant number of investors, especially by individuals whose bonds were purchased by institutional investors such as pension funds.”
At the time, Macías explains, two important decisions were made that eventually restored peace to the markets. First, they eliminated restrictive regulations that had forced foreign funds that entered Colombia to remain in that country for at least one year. Second, they authorized that transactions made on credit could mature early in those cases where both parties were in mutual agreement, and where those transactions had resulted in losses.
For Colombia, as elsewhere in Latin America, what happened next was not encouraging, says Macías. “Normally, interest rates rise because the economy has a high growth rate, and that leads to rising prices. But this time, inflationary pressures appeared in the middle of an obvious global slowdown. The effect on Latin America has been doubly negative. On the one hand, capital has fled to those locations where it can find higher yields. On the other hand, the lower level of demand generated by the [economic] slowdown will lead to a decline in prices of [Latin American] products exported to developed countries.”
Macías argues that eliminating the minimum period for foreign capital to remain in Latin America has been very harmful in Colombia and elsewhere. Regarding Chile, widely considered the most open country in Latin America, Macías says, “They kept their capital controls in order to prevent speculation unlike Argentina, which opened itself up. That approach made Argentina much more vulnerable and converted the country into an [unofficial] recycling facility for every international crisis.” Macías believes that deciding to “openly permit speculation in a country is clearly no guarantee that capital will enter [that country] and stay there. This approach exposes a country’s economy to international fluctuations, and significantly increases its economic volatility. The country winds up vulnerable to both external shocks and any volatility caused by internal decisions.”
Analysts anticipate a higher level of stability for 2007 now that investments that were temporally remaining in Latin America have gone back to their markets at home. What’s more, Macías believes that it is quite possible that the region will receive its share of new long-term foreign direct investments next year.
Carlos Esteves, an economist and professor of international finance at UCES, an Argentina university for business and the social sciences, links developments in Latin American stock markets with U.S. Federal Reserve policy in 2007. “If there is no change in the way the federal funds rate behaves, whether a strengthening or a drop [in the rate], then the future can turn out to be attractive for markets. It could also happen that, despite everything said earlier, the slowdown in the American economy is more intense [than anticipated]. In such a case, even if interest rates remain stable, there could be some disturbances that affect markets.”
Esteves believes that the most attractive sectors for investment are energy, infrastructure, communications, agribusiness, tourism, and basic supplies. Generally speaking, says Esteves, “There is a whole range of significant investment opportunities in the region, depending on the specifics of each country. Given stable political conditions, these trends could have an even more profound impact.” In some important countries, however, the electoral process of 2006 could introduce a certain degree of uncertainty, he says.
India Is Rocking
India’s stock markets seem to have everything going for them, from robust GDP and FDI growth to buoyant corporate earnings and a reasonable inflation rate. The bellwether Bombay Stock Exchange Sensex has more than doubled in the past two years, and cheerleaders are talking of another doubling in six years from now.
Specifically, India clocked GDP growth of 9.1% in the first half of the current financial year, foreign direct investment is at an annual run rate of $12 billion (compared to $7.7 billion last year), corporate earnings are set to grow 25% this year, and foreign institutional investors are thronging India’s bourses.
Most investment banks and brokers share a bullish outlook for Indian stock markets in 2007. Citigroup research analyst Ratnesh Kumar, in his latest outlook for the equity market in 2007, says the premium for Indian stocks is expected to be sustained because of the “widespread belief in the long-term structural growth story in India and robust fund flows.” He sees FDI inflows averaging $10 billion annually from the current three-year average of $5 billion, driven by “positive economic growth momentum and relative insulation to a global slowdown,” aided by continued economic liberalization moves by the government and an optimistic outlook for the BPO industry. “The impact of a scale change in FDI inflows … will further strengthen India’s ability to withstand oil price spikes and volatility in portfolio inflows,” says Kumar.
The stock market rally has been across the board, with impetus coming from the IT, automobile and commodities industries. Arjuna Mahendran, chief economist and strategist, Asia-Pacific, at Credit Suisse in Singapore says there has been a shift since 2005 in the underlying fundamentals of the economy, with the service sector providing much of the incremental growth since 2005. The current rally, he notes, is driven by the earnings growth at Indian publicly held companies. Indian-listed companies last year posted an average earnings growth in excess of 23%, the highest in Asia, he says.
A benign global interest scenario and technological advances that helped India’s business process outsourcing industry are key to the stock market boom, says V. Anantha Nageswaran, head of investment research (Asia-Pacific and Middle East) at Bank Julius Baer in Singapore, a wealth management firm with global headquarters in Zurich, Switzerland. “One should not underestimate the beneficial importance of these two last two serendipitous factors from the Indian standpoint,” he says.
Mahendran believes that Indian companies will not only retain their earnings growth but also increase market share. Citigroup’s Kumar echoes this view, noting that Indian companies will post earnings growth of 25% up to March 2007, and then 15%-20% for the rest of the year. He says the moderation in credit and higher interest rates will be among the chief factors tempering the growth in corporate earnings in the latter half of 2007.
Could it be that funds are chasing all available assets and currently, India is the flavor of the season? Not really, says Nageswaran, pointing out that stock markets have been booming also in countries that do not boast India’s growth numbers. Yet, foreign institutional investors are not expected to raise their allocation for India in 2007. Mahendran says the rise in allocations has already happened. “They are now likely to reassess the situation.”
In that reassessment, most market players will keep a keen eye on the direction of U.S. interest rates. Many analysts believe that the stock markets have already factored in a Fed rate cut in the U.S. in 2007. Julius Baer’s Nageswaran suggests that higher U.S. rates could cause many funds to move from emerging market equities to the U.S. bond market.
It is not just long-term funds that could cause volatility in India’s stock market. The huge unregulated hedge fund industry has been an important factor in countries such as India. The role of hedge funds in the global financial market, says Nageswaran, “is being understated because … the focus [is] on their assets under management.” While hedge funds are smaller compared to long-term mutual funds, he adds, they have access to relatively cheaper money. Credit Suisse’s Mahendran predicts that “if the India re-rating story comes to a halt, one could see volatility rise as investors take trading calls on a daily basis.”
Other negatives loom on the horizon for the Indian equity markets. Citigroup’s Kumar sees India facing “potential headwind” from a slowdown in credit growth, a talent shortage, elections in India’s largest state of Uttar Pradesh and the waning of global risk appetites. He says wage inflation is a significant threat to corporate profitability in 2007 and predicts that the service sectors will be most vulnerable to higher wages. But a growing talent shortage and migration of middle-management skills to the service sector could fuel wage increases in the manufacturing sector.
The first step towards credit moderation has already taken place, with the Reserve Bank of India last week raising the mandatory cash reserve. That move could take Rs. 13,500 crore ($3 billion) from the system, cause interest rates to rise and dissuade borrowing in segments such as personal finance, home loans and auto loans.
The prospects of a rise in interest rates seem more certain than earlier, especially as 5% inflation levels show no signs of getting out of control. The Indian government has already cut fuel prices, permitted private firms to import wheat and retained its ban on sugar exports, among other measures — all with the objective of combating inflation. But those measures may ultimately prove inadequate to keep prices in check. “The shortage of wheat globally could stoke inflation,” says Mahendran. “Rates could rise, and that would affect consumer finance.”
Swaminathan Aiyar, a columnist for the Sunday Times of India, writes about possible scenarios that could go wrong and spoil the Indian stock market party. “Something will give. The housing market in the U.S. could crash, leading to a chain-reaction of recessions in countries exporting to the U.S. The greatest threat of all is renewed terrorist attacks on the U.S. It is only a matter of time before suicide bombers, so common in the Middle East, detonate themselves in the U.S. rather than in Palestine or Iraq.”
For the long term, however, Aiyar is sold on the India growth story. “The path of the world economy and stock markets could be a roller coaster…, but if you have faith in India’s future, then you should close your eyes and sign up for the ride.”
The View from Inside China
Zheng Chaoyu, director of the Institute of Economic Research at Renmin University in Beijing, suggests that in 2007, China will experience low inflation and a 9.25% growth rate, higher than the official prediction of 8%, but not as high as 10% “because the fixed-asset investment growth rate will continue to drop, and the export growth rate will be lower due to such factors as RMB appreciation.” Zheng also thinks that the government will continue its “moderate and stable finance and currency policy…. No drastic changes are expected.”
According to a report he contributed to, titled “China’s Macro Economy and Policy: 2006 and 2007,” the annual RMB appreciation rate will be at 6% between 2006 and 2010. “Our estimation is probably too bold,” he notes. “But since the beginning of exchange rate reform, the actual exchange rate change was 2% to 3% higher than many people’s expectation.”
Zheng believes that the upward trend of FDI in China will be sustained in 2007. “We have a huge market and cheap labor, which is most attractive for foreign investors.” Labor costs, he acknowledges, are “on the rise but will not have a [negative] impact in the short term.” Long term, he adds, it is unclear whether productivity growth will counteract the impact of higher wages. His report assumes that wages will be growing at 10% annually.
As for China’s regulatory systems, Zheng points out that “foreigners always talk about how severe the regulations are for foreign businesses, but they are actually more severe for domestic businesses.” Zheng predicts that in the future, “policy makers will pay more and more attention to compliance.” Many policies, he adds, “cannot be implemented easily and they are not as tight as people assume.” Zheng says he is very impressed by “the ability of foreign companies to find ways to bypass policy barriers.”
Chinese enterprises will continue to expand abroad in 2007, Zheng states. The key growth areas “will be the resource sector and emerging markets. But there will not be too many companies [going abroad] since the government is concerned about capital flight, corruption and the outflow of state-owned assets.” At the same time, he adds, the surge in off-shore listings will not slow down, “especially for state-owned enterprises, because of government support.”
Zheng’s prediction for an average 9% growth rate over the next 10 years is based on the country’s rich labor resources, high savings rate and potential for technological improvement and institutional change. “The workers in Guangdong province work day and night with a monthly salary of less than $150. Frankly speaking, I don’t think there is any ‘miracle’ in China’s economy,” he says, reflecting the view that the industriousness of the people in China’s provinces is responsible for China’s growth, not a “miracle,” as some media like to label China’s recent successes.
Scott Zhu, Chief Investment Officer of Wanjia Asset Management Co., offers another perspective on the year ahead. The China capital markets experienced “explosive growth” in 2005 and 2006 which will “continue over the next three to five years,” he says, citing three major causes for this significant improvement. First has been continuous and sustainable GDP growth for the past 25 years -– with an average 9.6% growth a year –- which he describes as “phenomenal.” Many economists believe that “China’s GDP will grow at least 7% annually over the next five to ten years,” he adds. “Second is the growing expectation of RMB appreciation against the dollar and other currencies. Third, in 2005, the Chinese government started a program to make non-tradable shares into tradable shares. Already 90% of the market’s shares are tradable.”
Zhu notes other factors that he says have helped the capital markets take off and that signal his optimism for the stock market’s continuing growth next year:
- The return of several off-shore listed blue chip companies to the domestic market this year
- Further privatization of the state-owned enterprises, such as the listing of the Industrial and Commercial Bank of China (ICBC) in October
- An internationally-recognized new accounting standard that will be in place in 2007
- Further regulations, to be rolled out next year, that will help companies endow senior management with stock-based options and other incentives
- Further expansion of the QFII (Qualified Foreign Institutional Investors) quota next year, which will open the door wider to international players
- The roll out, by regulators and the stock exchange, of new products, such as margin trading, warrants, stock options and index futures, all in 2007.
According to Zhu, “the amount of funds raised in China’s equity markets this year was the third highest in the world. If we combine the stock markets in Shanghai, Shenzhen and Hong Kong all together, the number would surpass the funds raised in the New York Stock Exchange for the first time ever.”
Another number has also strengthened his confidence in the performance of China’s stock market. “Up through the first week of December 2006, the total market cap in the China market is above 7.3 trillion RMB, more than double last year’s market cap and equal to about 36% of China’s GDP. I would expect that by the year 2010, the total market cap of the Chinese equity market would account for somewhere around 50% of the country’s GDP.”