Why are China Bank Stocks rallying and can it last?
China's major banks have experienced a significant surge in their share prices, with the four largest banks in the country witnessing gains of 6% or more within a mere five-day period. Among them, the Bank of China emerged as the top performer, achieving an impressive 17% increase in its share price.
I find it peculiar since the stocks of these four banks have limited price movements. Over the past five years, ICBC's stock has remained within a range of ¥4.22 to ¥5 (adjusted for dividends), showing little price gains.
Thanks to their price stability, these bank stocks are highly favored by dividend investors who appreciate their reliable and substantial yields. Provided below are the average dividend yields of the Big 4 banks over a five-year duration:
Bank of China: 8.9%
China Construction Bank: 7.2%
ICBC: 6.4%
Agricultural Bank: 5.7%
Furthermore, these Chinese banks rank among the largest financial institutions globally and are part of the top six banks in the world based on market capitalization.
It is indeed unusual for banks with such prestigious status to trade at high dividend yields. Even during the banking crisis in the US, where Chinese banks remained unaffected, financial giants like JP Morgan Chase and Bank of America had relatively low dividend yields of around 3.2%.
Contrary to the belief that US bank stocks offer lower dividends and prioritize share buybacks due to higher dividend taxation, the reality is that both US and Chinese banks maintain similar payout ratios. Both countries' banks distribute approximately 30% of their profits. Thus, the China banks are trading at much cheaper valuations compared to the US counterparts.
One potential explanation for this discrepancy is that these banks are state-owned enterprises, and there exists a general skepticism surrounding China's governance, particularly among foreign investors. Consequently, the share prices of these banks are compelled to trade at a discount to account for this perceived risk.
Given that China bank stocks are typically associated with price stability and the majority of returns come from dividend gains, it raises curiosity as to why the share prices experienced such a sudden and substantial rally within a short period. I was intrigued to delve deeper and understand the underlying reasons behind this surge.
Towards the end of last year, Yi Huiman, the chairman of the China Securities Regulatory Commission (CSRC), emphasized the need for a distinct valuation approach for State-Owned Enterprises (SOEs). He argued that due to their unique management methods, operating models, and business characteristics, conventional valuation methods might not be suitable for SOEs. He further emphasized that China's economic system, being a socialist market economy with distinct characteristics, cannot simply adopt Western evaluation models.
While Yi Huiman's remarks seemed reasonable, the primary issue at hand appears to be the comparatively low valuations of SOEs, as indicated by the high dividend yields of banks. To enhance the perception and ultimately influence the share prices of SOEs, a new valuation method is being developed. Yi Huiman referred to it as the "valuation system with Chinese characteristics" or ä¸å›½ç‰¹è‰²çš„估值体系.
Following his speech, there has been increased media discussion regarding this topic. In April, Wang Qian, an Associate Professor at Tongji University, published an article suggesting potential considerations for the new valuation system.
As a result, it is plausible that the introduction of the new valuation system could lead to higher valuations for SOEs. Even though the specifics of this system have yet to be established, investors are preemptively positioning themselves to benefit from it, which could explain the recent rally in China bank stocks.
In addition to the surge in bank stocks, state-owned enterprises (SOEs) operating in various sectors such as construction, telecommunications, and commodities also experienced an increase in their share prices, although not to the same extent as the financial sector.
Is it good to enter the bank stocks now? Since their dividend yields (TTM) remain attractive even after the surge:
Agricultural Bank: 6.2%
ICBC: 6.0%
China Construction Bank: 5.9%
Bank of China: 5.4%
In my opinion, it may not be advisable to buy these bank stocks at this time.
Given that the new valuation system for state-owned enterprises is still being developed and its specific details are unknown, there is significant uncertainty surrounding its implementation. There is even a possibility that the new valuation system may not be put into effect at all. With so many unknown factors, it is challenging to make informed investment decisions.
Moreover, China bank stocks have a historical tendency to experience sudden surges in share prices followed by rapid declines. This volatility adds another layer of risk for potential investors.
Take ICBC as an example, observe the instances of price spikes:
Next is Bank of China:
Agricultural Bank showed similar price patterns:
Last but not least, China Construction Bank suffered from the same effect:
Therefore, I hold the belief that the current rally is unlikely to be sustainable, and it is probable that prices will eventually revert back to their previous trading ranges.
Indeed, at the time of writing, the prices of these bank stocks have experienced a decline. Just within a single day, on May 10, 2023, we witnessed the following changes:
ICBC: -5%
Bank of China: -5%
China Construction Bank: -5%
Agricultural Bank: -6%
Given this recent downward movement, it seems more prudent to exercise caution and wait for the hype to settle before considering an investment in these banks for the purpose of dividends.