Chinese And Philippine Stocks Facing Downside Risks

Chinese stocks are clearly in a world of their own, and warrant a significant amount of caution. We wrote on May 15 that the rally in mainland stocks was looking increasingly unsustainable, and that the fundamentals were not likely to catch up with lofty valuations. While we still believe that the Hong Kong-based HSCEI has potential to catch up with the mainland indices, there is an increased likelihood that mainland stocks 'catch down' instead.

The Shenzhen Composite's price ratio versus the HSCEI is at extremes and its P/E (price to earnings) ratio is trading at a record premium of almost 70x. The 7% decline in the Shanghai index on May 28 upon news of margin trading curbs highlights the downside risks, and we may adopt a bearish outlook over the coming weeks.

Meanwhile, we have adopted a bearish view on the Philippines Composite, which, like China, trades at a huge premium to emerging market (EM) and global valuation averages. Despite the Philippines' strong economic growth outlook, a larger risk premium is warranted. Corporate governance, while improving, is still weak, and there are political risks surrounding the May 2016 general elections, which will determine who succeeds President Benigno Aquino III. Weakening price momentum warns of a 20%+ correction in Philippine equities over the remainder of 2015.