China’s US$11 trillion stock market will have to wait for a couple of breakthroughs from cyclical and defensive sectors before prices can snap out of their tight range over the past two months and mount another rally.
The recent market-beating performance of defensive stocks and their appeal over cyclical peers are poor signals for foreign investors, Jing Sima, a strategist at BCA Research, wrote in a note to clients on April 28. The trends reflect concerns that China’s economic growth has peaked after last quarter’s 18.3 per cent annualised expansion.
The view has gained traction as the market languished in a tight range over the past two months as foreign funds bet US$432.6 billion of their money in the market. Chinese cyclical stocks – proxied by energy, materials, and consumer discretionary among others in MSCI China gauges – have remained depressed in onshore and offshore markets, Sima noted.
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“Given that the indicators remain firmly in a risk-off mode, we maintain our view that China’s economy has reached its peak, and policy has tightened meaningfully,” Sima said. “Our cyclical underweight position, in both absolute terms and within a global portfolio, is warranted.”
BCA Research last month downgraded its tactical (zero to three months) and cyclical (six to 12 months) positions to underweight relative to global benchmarks, after lowering them to neutral in mid-January, citing valuations and policy miscalculation risks amid tightening regulations.
The CSI 300 Index of biggest stocks listed in Shenzhen and Shanghai, reached a 13-year high on February 10, slumped more than 14 per cent within a month, and has since traded within a 240-point range.
The Shanghai Composite Index has lost 6 per cent from its February high, and drifted sideways for the past seven weeks. Tighter monetary policy and a widening antitrust crackdown have prompted money managers like BlackRock to trim their holdings.
Chinese stocks will not break out of their rangebound patterns until the performances of defensive stocks like utility and health care are reversed. When that happens, it may be viewed as a signal that investors are acknowledging the growth outlook and ride the upturn, according to the report.
A technical breakdown of these stocks historically leads China’s economic activities, inflation and stock prices by one to three months, Sima added.
The People’s Bank of China has begun to cool loan growth since October as part of a policy shift, Sima said. Given credit growth typically leads the economy by six to nine months, China’s growth will probably start to decelerate in the second quarter, she added.
“Most clients shared our concerns that policymakers may keep financial and industry regulations more restrictive than the market is currently pricing in, leading to more downside surprises to risk-asset prices,” said Sima.
“They foresee sustained volatility in the coming months as the market continues to struggle between digesting high valuations and adjusting expectations for future earnings growth.”
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