A dismal year for China’s stock markets has given rise to an unusual situation: Foreign institutions seem more optimistic about prospects for the country than local investors.
Overseas money has poured into Chinese equities this year via a trading link with Hong Kong, despite a 16% decline in Shanghai stocks that has made it one of the world’s worst-performing major markets. But trading volumes in Shanghai, which are powered by an army of retail investors, last week fell to their lowest level since January 2016 when the market was in the midst of an unprecedented crash.
“There is a rare dynamic right now, with foreign investors more positive on Chinese stocks than local investors,” said Kinger Lau, chief China equity strategist at Goldman Sachs in Hong Kong.
Mr. Lau said U.S.-based hedge funds are looking for opportunities to buy in China given that the market is cheap both by recent historical standards and relative to U.S. stocks. The Shanghai market is trading at 10.4 times expected earnings this year, according to Thomson Reuters, well below the S&P 500 of 18 times.
While foreign buyers appear to be focused on potential bargains, local investors are worried by government attempts to rein in credit and a burgeoning trade dispute with the U.S. That has led to fragile confidence in stocks, despite official data showing the economy is still growing at more than 6% a year.
Foreign inflows were set to rise again last week when index provider MSCI was to increase the weighting of stocks listed in mainland China in its widely followed Emerging Markets Index. Passive funds which track the index will then automatically have to buy more of the roughly 230 Chinese companies that were first included in May.
Partly thanks to MSCI, foreign ownership of Chinese-listed stocks has risen to 3.5% of the market, up from 3% at the start of the year, according to BNP Paribas. Some $31 billion has flowed into China’s two main markets—in Shanghai and Shenzhen—through the trading link with Hong Kong this year. That is tiny in the context of an $7.4 trillion market, but still more than flowed in during all of 2017.
Index inclusion isn’t the only factor luring foreign institutions. “We’re definitely looking at A-share companies more on the buy side now than six months ago,” said Andrew Mattock, a San Francisco-based portfolio manager at Matthews Asia, using a term for yuan-denominated shares listed in Shanghai and Shenzhen.
“Valuations had become stretched at the end of last year, but now there are more opportunities,” said Mr. Mattock, who manages the firm’s China strategy. He said he is looking in particular at companies making consumer goods, as well as some industrial stocks and big Chinese banks.
The relative popularity of Chinese stocks with foreigners is a turnaround from prior years when some well-known U.S. money managers warned about the dangers facing China’s economy. Leading hedge-fund manager Kyle Bass was among those who bet big against China last year, only to suffer heavy losses when the yuan rallied.
It is also a contrast to the downbeat mood among Chinese individual investors. “Everyone can see that our economy is in pretty bad shape and the stock market is a barometer of that,” said Wu Yunfeng, a retail investor in Shanghai. “The state media have been portraying our country as the strongest in the world for years and we have become so complacent.”
Within China, the government’s so-called deleveraging campaign, in which it has tried to stem high levels of debt by curbing the country’s shadow banking, intensified through the early months of the year. The move affected stocks in two ways: First, because of a fear that slower credit growth would cause the overall economy to falter; and second, because of a crackdown on popular investment products sold by banks that had helped drive equities purchases in recent years.
The U.S. government’s April ban on U.S. firms selling components to telecom company ZTE Corp. also hammered market confidence as it demonstrated Washington’s willingness, and ability, to hobble a leading Chinese company. That shock has hardly abated even though the Trump administration subsequently agreed to lift the ban and fine ZTE $1 billion instead.
A growing realization that the U.S. government is willing to take on China over trade has since deepened investor concerns. One major worry is that employing Beijing’s old playbook of borrowing and spending freely on infrastructure won’t be enough to stem slowing growth—and that the government is unwilling to undertake deeper structural reforms that might give investors hope of a more vibrant economy.
“We can’t go back to the massive stimulus program of 2008 because leverage in the Chinese economy is already very high,” said Deng Wenyuan, an analyst at Soochow Securities based in the eastern city of Suzhou, adding that bolder reform was needed.
Mr. Wu, the retail investor, said he plans to stay out of the market for now. “We don’t actually blame Donald Trump because we understand that he needs to serve the American people,” he says, referring to the market downturn. “It’s his job. It’s our government’s job to take care of us and we want to see more action.”
Source: The Wall Street Journal
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