The Week In Hindsight 14 February 2014

The Shanghai Composite Index continued to push higher throughout the past week as trading picked up following a quiet new year period and economic data indicated higher than expected inflation and a strong trade surplus throughout January.

Despite the upset in emerging markets, along with concerns over local growth itself; bullish forecasts currently remain in place for Chinese stocks which have remained unaffected throughout the recent sell off. This could indicate that valuations are heading for a broader correction to the upside in China.

However, the area of concern that still remains is the financial sector. With credit creation continuing to expand at a rapid rate in the shadow banking industry, amidst a slowing economy, many analysts have forecast a wave of defaults among wealth managers and corporate lenders for 2014.

In addition to this, there is rising concern over the use of “off – balance sheet” vehicles among financial institutions.These were popular in developed markets during the run up to the financial crisis as they enable institutions to disguise the true level of their liabilities.

The prevalence of such tactics makes leverage ratios harder to enforce and financial firms more difficult to regulate from a prudential perspective. Should any of these factors culminate in further financial instability within China then the optimism that currently surrounds CNY stocks could soon fade.

We continue to believe that price action in China is best observed from a safe distance for the time being. The next major announcements to emerge from the nation will be a measure of new loan origination on Tuesday which is forecast to show credit creation taking a place at a record pace while Wednesday sees the HSBC flash manufacturing PMI released.

Many will remember that this is one of the barometers credited with igniting the global sell off which took place in January. The current forecast is for the index to remain in contraction territory by posting a further fall from 49.5 down to 49.4.