Chinese equities boomed in late 2022 after the much-anticipated lifting of Covid restrictions that were among the world’s strictest. Fast forward nearly a year, and the reopening gains have evaporated amid a steady drumbeat of disappointing economic news, leading to a US$3 trillion ($4.11 trillion) equity rout. Foreign funds have been steady sellers even as the government has undertaken a barrage of measures to try to prop up domestic markets and the economy. A structural divestment from the world’s second-largest stock market would make it harder for China to raise overseas funds to help finance future growth.
1. What is scaring global investors away from China?
This was supposed to be China’s comeback year, but investor sentiment has been dragged down by prolonged trouble in the property sector, local government debt stress and growing US-China tensions over semiconductors and other technology investments. China’s economy gained momentum in the third quarter, but there’s a lot of trepidation about calling a bottom, especially as real estate remained a sore spot. Yuan weakness and consumer price deflation are adding to worries about corporate profits. Indeed, earnings expectations for the MSCI China Index are looking overly optimistic by one metric, according to Bloomberg calculations. Other factors include worries about another crackdown on private enterprise such as what hit Big Tech a few years ago, low trust in the government following President Xi Jinping’s consolidation of power in 2022, and increasing opacity following raids at consulting and due diligence firms that help global investors understand the country.
2. How has China responded to the drop in foreign investor interest?
In October, the sovereign wealth fund increased its stake in the country’s big banks and promised to keep buying, while authorities tightened short-selling rules to stem the market slide, which saw the CSI 300 Index fall to pre-reopening levels on Oct 20. The same day, the central bank injected record cash into the banking system to boost liquidity in the system and keep funding costs low. China is also said to be mulling a market stabilization fund.
3. How bad is the foreign fund exodus?
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Any government measures have only provided short-term relief to key equity benchmarks, if at all. The CSI 300 Index is on track for an unprecedented third year of declines, and Morgan Stanley is warning investors against buying the dip. Global funds are about 66 billion yuan ($12.35 billion) away from making 2023 the first year they sell Chinese shares on a net basis since trading links opened in late 2016. A strategy of stripping China out of emerging-market portfolios has been gaining traction, with launches of stock funds that exclude China already reaching a record annual high in 2023. US and European funds shed nearly US$2 billion of China and Hong Kong equities on a net basis in October, after slashing average positions to the lowest since 2020 last month, according to EPFR data. That’s contributing to turnover in Chinese and Hong Kong markets falling to multi-year lows.
4. Why are people talking about the ‘Japanification’ of China?
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China’s economic landscape and demographics are looking similar in some measures to Japan’s in its post-bubble era 30 years ago, sparking worries that Chinese equities may be facing the risk of what’s come to be called Japanification. JPMorgan Chase & Co. strategists have said in multiple reports that the repricing of Chinese assets is structural, rather than cyclical, meaning that investors are likely to assign them a higher risk premium (and ask for a lower price) for a long time. Worries over a balance sheet-recession, where companies focus on cleaning up of debt excesses rather than investment spend, are pronounced. Investors are drawing other parallels between China and Japan, such as deflationary trends, an ageing population and slowing economic growth.
5. What’s next for China’s markets?
Amid a lack of other catalysts, investors have tended to rely on policy meetings for direction. The top decision-making body Politburo usually meets in the final days of each month, while the Communist Party is expected to hold its third plenum in the coming months. Bloomberg News reported that China also plans to convene a key financial policy gathering, which is held every five years. A potential meeting between Chinese leader Xi Jinping and US President Joe Biden at an Asia-Pacific economic summit in November could allay some geopolitical concerns. The Central Economic Work Conference to be held in December is being watched for policy direction in 2024.
Chinese equities have wiped US$3 trillion in market value since their peak earlier this year.
What’s driving global investors to ditch China stocks and is there an end in sight? @IshikaMookerjee explains https://t.co/ma3avTUr0J pic.twitter.com/7far80Chl9
