China stocks, a core holding for the world’s biggest money managers, are suddenly unloved after a five-week slump. The US$10.8 trillion market is edging closer to a bear-market tipping point amid bubble and Fed policy risks while trading has cooled, and the safest old-economy stalwarts are the only game in town.
The Shanghai and Shenzhen bourses have lost the equivalent of US$140 billion in market value since the CSI 300 Index peaked on February 10, lately hurt by gyrations in the US bond market. On March 17, their combined turnover shrank to 691 billion yuan (US$106.2 billion), the lowest level this year.
As caution prevailed, local investors have turned to the safest stocks for cover. Since the CSI 300 Index peaked on February 10 and slipped in the following five weeks, utilities and energy producers were the only winners among the industry sectors. Popular bets in health care, consumer staples and tech suffered the biggest losses.
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“Being defensive is the best strategy for now,” said Li Lifeng, a strategist at Huaxi Securities. “The market may stage a short-term rebound, but I still do not see that it will be in for an upward trend again.”
While China’s economic power has boosted the allure of yuan-denominated shares among stock index compilers, that global recognition also comes with a price – in the form of greater exposure to market volatility caused by swings in sentiment and capital flows. Since the nation’s top banking official warned of financial-market bubbles on March 2, losses have snowballed amid a sell-off in the US Treasury market.
That is not too assuring as indices tracking Chinese cheap and expensive stocks are highly correlated to the US bond market over the past five years, according to Lin Sishan, an analyst at Central China Securities.
“When yields on longer-dated notes surge, market expectations will intensify that the Fed will tighten policy to rein in inflation,” Lin added. “That will lead to narrowing interest-rate spreads, spurring an outflow of foreign funds, and pressuring high-valuation stocks.”
Other signs are also worrisome.
The market slide from the peak has pushed the Shanghai Composite Index to within 2 per cent of breaking below the 200-day moving average, a line deemed as a bull and bear market divider. For the MSCI China A Onshore Index, the margin is slimmer at 0.9 per cent.
Failure to hold above that support may spell an end of the current uptrend that began from the depth of Covid-19 pandemic in March last year.
“The recent price correction in Chinese stocks has not yet run its course,” analysts led by Jing Sima at BCA Research wrote in a report to clients on March 17. “Moreover, equity prices in both onshore and offshore markets are breaching their technical resistance.”
The analysts downgraded the market to underweight on a tactical and cyclical basis over the next 12 months relative to global benchmarks, saying the risk of policy over-tightening in China is “non-trivial” as the government juggles growth targets while keeping holding down fiscal impulse.
Morgan Stanley and Credit Suisse had earlier this year also lowered their opinion on China’s stock market, according to media reports.
Not all is lost, though. For market optimists, the forthcoming earnings season may induce some relief rally. The 300 companies in the CSI 300 Index will probably report a 33 per cent jump in profit in the March quarter, compared with a 24 per cent decline a year earlier, according to Bloomberg data.
“Domestic economic fundamentals can be expected to become the deciding factor,” said Lin at Central China Securities.
Until then, the tumult in the Treasury market is likely to keep stock investors at bay as the future path of US borrowing costs, or the speed at which the Federal Reserve is likely to taper its bond purchases, continues to sway the market. There is also the unresolved US-China differences on several fronts, with the Alaska meeting achieving little.
“The risk-free interest rate in the US still has upside room to run on the backdrop of the fiscal stimulus and massive vaccination,” said Yang Lingxiu, an analyst at Citic Securities, China’s biggest publicly traded brokerage. “That’ll lead to further downside on US stocks in the short term.”
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