Chinese stocks could be in for another wild ride during July, and Chinese solar stocks could be dragged into the mess. The two most volatile Chinese solar stocks, TSL (Last trade $44.63) and JASO (Last trade $29.21), seem particularly vulnerable to wild swings in Shanghai.
Liquidity is the main concern of Chinese regulators. The inflation-adjusted one-year deposit rate of 3.06%, after deduction of 20% withholding tax, means that the real rate in China is negative by about 1 percentage point. The negative real rates means that Chinese investors are losing out by leaving cash in a savings account, and for this reason it makes sense for them to move money out of savings accounts and into the booming stock market. The flood of liquidity has pushed Shanghai stocks to new records and everyone agrees that valuations look stretched.
Chinese authorities have now introduced a Qualified Domestic Institutional Investor (QDII) scheme to try to address the liquidity problem. The expanded QDII program takes effect on July 5, and will allow Chinese institutional investors to invest client funds in overseas fixed-income, equity and derivative securities. Chinese officials hope the scheme will take some liquidity out of the booming Chinese stock market. To read more about QDII please click here.
Regulators are betting that Chinese institutions will choose to exit some funds from the Chinese stock market, where valuations are seen as excessive, and move funds to Hong Kong, where valuations are cheaper. Hong Kong's H-share index (an H-share is a share of a Chinese company listed on the Hong Kong Stock Exchange) currently trades at a forward price/earnings ratio of about 19.2 times. Shanghai-listed A shares currently trade at 45 times projected 2007 earnings. There is currently no arbitrage system between Hong Kong-listed shares and Shanghai A shares.
For Chinese solar stocks, we need to consider three scenarios. The impact of these scenarios depend on how Chinese retail investors react to the liquidity developments in Shanghai. Retail investors hold more than 60% of the market value in China's two bourses, and the events of February 27 serve as a reminder of just how quickly this market can panic.
Scenario 1: Liquidity dries up and Chinese stocks plummet: In this scenario, a massive flow of institutional funds from Shanghai to Hong Kong drains more liquidity than expected, and Chinese retail investors panic. The Peoples Bank of China has said on several occasions that there are signs of overheating in the Chinese economy, and further monetary tightening can add to the panic. A large sell-off in Shanghai could once again hit Chinese solar stocks.
Scenario 2: Common sense prevails: There are several reasons why Chinese institutional investors may avoid investing too heavily in Hong Kong shares. The Hong Kong Dollar has been steadily depreciating against the Yuan, so some investors may be reluctant to move funds to Hong Kong due to forex movements. There is also a huge opportunity cost attached to moving funds to Hong Kong, as the Chinese stock market is showing no signs of slowing down. Some liquidity may be drained from Shanghai bourses, but the upward momentum of Chinese stocks will likely continue. I suspect this scenario will have a neutral impact on Chinese solar stocks.
Scenario 3: The QDII scheme fails to have the desired effect, and China goes 'pop': Chinese institutions may feel that the opportunity cost of leaving the booming Chinese stock market is too great. The Chinese bourses will continue to be flooded with liquidity and the Peoples Bank of China could become more desperate with existing measures failing to have the desired effect. A desperate Chinese central bank amid an overheating economy will likely scare retail investors. The Chinese bubble could pop, and Chinese solar stocks will take a hit.
Any Chinese solar sell-off inspired by a Shanghai correction (or crash) could present some good buying opportunities, because the fate of China-based PV companies is not directly tied to the economic future of China. The bulk of sales of China-based PV manufacturers (>80%) are to Europe and the U.S.
A list of U.S.-listed Chinese solar stocks:
TSL (Last trade – $44.63)
JASO (Last trade – $29.21)
SOLF (Last trade – $8.98)
STP (Last trade – $33.10)
CSIQ (Last trade – $10.46)
Disclaimer: I do not own any of the stocks mentioned above. I don't own a solar panel.
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