China’s wild market ride throws investors

PBoC cuts interest rates after Shanghai’s benchmark index flirts with bear market territory. New users of Shanghai-Hong Kong Stock Connect caught in market whiplash.

Investors in China’s mainland stock markets look set for another bumpy ride next week after Beijing cut interest rates on Saturday, facing-off with stock market pundits who say equity valuations are too high.

China’s central bank said on Saturday it would cut rates by 25 basis points and trim the reserve requirement ratio for financial institutions.

“The government appears eager to maintain a bull market to expand the capital market and reduce reliance on bank lending, although the use of monetary policy for that purpose is questionable,” said Lan Shen and Shuang Ding, economists at Standard Chartered in a note to investors on Saturday.

The People’s Bank of China (PBoC)’s move follows a 7.4% drop in Shanghai’s stock market to 4,192.87 points on Friday about 19% off this year’s high hit on June 12. A bear market is commonly defined as a greater than 20% drop in market bench markets over at least two months.

“The balance of probabilities is that the top for the cycle on Shanghai, Shenzhen and Chinext has now taken place,” said Morgan Stanley chief Asia strategist Jonathan Garner in a report released Friday citing increased equity supply, weak earnings growth in the context of economic deceleration, high valuations, and very high margin debt to free float market capitalization.

He said while its true Chinese authorities have been vocal in their suport of the rally "governments are not able to exert direct control over stock market behaviour, in particular where trading volumes, valuations and margin leverage are as stretched as they are now in China".

More than 40% of Shanghai-listed stocks by number are now trading at over 80 times historical earnings, higher than when Chinese equities peaked in 2007. 

Beijing is rapidly opening up its stock markets to foreign investors in the hope that they may ameliorate some of the wild price swings in mainland shares known as A-shares with their more fundamental analysis and stock-picking style.

However overseas long-only institutional investors have been wary of buying the so-called A-shares as valuations have surged since November when China launched a two-way Stock Connect trading link between the Shanghai and Hong Kong bourses to ease access to mainland stocks.

FinanceAsia is hosting a conference to discuss Stock Connect on Monday in Hong Kong. Speakers at the event will include the chairman of Hong Kong Exchange and Clearing Chow Chung-kong; Chris Ryan, head of Asia Pacific MSCI and Fuzhong Liu Vice director of strategy at the International Relations Shenzhen Stock Exchange. 

Morgan Stanley banker Vincent Chui was drinking coffee with a small group of his hedge fund clients on May 28 when the Shanghai stock market sank 6.5%, following a bull market run to a seven-year high.

Chui and the hedge fund managers watched prices tumble on their smartphones but resisted any urge to sell. “You have to have a very strong stomach to trade China,” Chui told FinanceAsia.

So far users of Stock Connect have mostly been fleet-footed investors such as Asian hedge funds and Chinese private banking clients who are quick to profit from market volatility, according to market sources.

Hong Kong-based hedge fund managers, such as at Value Partners, Tree Line, and Keywise Capital Management, have been among the most active and successful traders. The HFRI China Index, which measures the performance of Chinese hedge funds, was up 13% in April, the strongest monthly gain since the index’s inception in 2008.

Meanwhile long-only asset managers such as pension funds, mutual funds and life insurers, have largely sat on the sidelines since November due to technical snafus in the set up of Stock Connect such as confusion over such issues as beneficial ownership. But volatility has also been a big worry for some long-only investors.

“The single biggest anxiety for long-term money going into China is volatility,” said Morgan Stanley’s Chui, who heads Asia institutional equity distribution and private wealth management at the New York-headquartered bank. “You have to be prepared for days when you are up or down more than 5% and there is no clear fundamental explanation.”

Many have been daunted by the prospect of going up against the 114.4 million retail investors registered on the Shanghai stock exchange who are largely sentiment and momentum driven.

One US broker as of April had around 300 long-only institutions signed up but only 30 of these had traded, according to a person at the firm. Some of the world’s largest investors such as BlackRock and Franklin Templeton Investments only made their first trades over Stock Connect in late May and early June.

“Velocity and volatility have increased which has impacted some investors’ confidence in the market, but they’ll have to get used to it,” said David Rabinowitz, head of direct execution services (electronic trading) in Asia at UBS.

China’s markets will continue to open and grow, with the addition of a trading link to Shenzhen’s stock market expected towards the end of this year and A-share inclusion in MSCI’s Emerging Market benchmark indices at some point.

Shenzhen is an even more volatile market. On Friday the Shenzhen Composite Index dropped 7.9% to 213.7 points entering bear market territory after falling more than 20% since June 12. Last year retail investors accounted for 86.7% of trading volume on Shenzhen’s market.


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