The China reform trade is backfiring in the stock market.
After soaring the most in two years on Nov. 18 as the Communist Party unveiled its biggest policy changes since the 1990s, the Hang Seng China Enterprises Index has since posted the world’s worst drop. An index of stocks JPMorgan Chase & Co. says benefit most from reform sank 10 percent this year through yesterday. A plan to link bourses in Hong Kong and Shanghai, which fueled a two-month rally when the idea was first floated in 2007, lifted shares for just one day when it was reintroduced in April.
While the November policy package led Goldman Sachs Group Inc. to raise its recommendation on Chinese shares to overweight and spurred Citigroup Inc. to predict returns of at least 20 percent in 2014, investors have shifted their focus to the depth of China’s economic slowdown. Instead of boosting stocks, the government’s emphasis on reform may impede gains as policy makers downplay the importance of short-term growth, according to CLSA Asia-Pacific Markets.
“Pessimism is running high on whatever China does or announces,” said David Gaud, who helps oversee about $120 billion at Edmond de Rothschild Asset Management in Hong Kong. Measures such as the exchange link would create a more sustained rally “in any other part of the world,” he said.
The competing influences of policy change and the economic slowdown were on display this week, with the Shanghai Composite Index rallying 2.1 percent on May 12 after China’s State Council said it will deepen capital market reforms, including relaxed limits on foreign investment. The gauge slid 0.1 percent yesterday as data showed unexpected decelerations in industrial output, investment and retail sales.
Expectations were high back in November. Goldman Sachs upgraded China stocks in a Nov. 21 report, saying the Communist Party’s pledge to boost private investment in state-controlled industries, protect rural citizens’ land rights and ease the one-child policy had “reinvigorated” reform expectations.
Credit Suisse Group AG said in a note on the same day that Chinese equities were among its three top recommendations in Asia. Shen Minggao, an analyst at Citigroup, said in a Nov. 26 report that the reforms would “unleash” the country’s growth potential.
Connie Ling, a spokeswoman at Goldman Sachs in Hong Kong, said a March report in which strategists reiterated their overweight rating on China stocks for Asia investors, represents the bank’s current view. Citigroup spokesman James Griffiths and Credit Suisse spokeswoman Noel Cheung said their firms’ analysts weren’t available to comment.
The Hang Seng China Enterprises gauge rose 1.4 percent at the close in Hong Kong, while the Shanghai Composite slid 0.1 percent. The Bloomberg index of the most-traded Chinese shares in the U.S. fell 0.2 percent to 100.91 in New York yesterday. American depositary receipts of Internet company Qihoo 360 Technology Co. slumped 4.3 percent, after jumping 8.1 percent on May 12.
The Hang Seng China Enterprises’ 13 percent drop since Nov. 18 through yesterday is the biggest among 70 global equity indexes tracked by Bloomberg and compares with a gain of about 4 percent in the MSCI All-Country World Index.
China’s reforms have been overshadowed by poor economic data, the nation’s property-market slowdown and a depreciating yuan, said Patrick Ho, head of chief investment office research in Hong Kong at UBS Wealth Management, which managed about $2.03 trillion globally as of the first quarter.
Factory production rose 8.7 percent in April from a year earlier, compared with the 8.9 percent median estimate of analysts surveyed by Bloomberg News. New building construction fell 22 percent in the first four months of the year, while home sales slid 18 percent in April. The yuan has retreated 2.8 percent versus the dollar this year and touched its weakest level since October 2012 last month.
“The market is looking at the downside risk to the economy,” said Ho, who has an overweight recommendation on Chinese stocks after advising investors to boost holdings on Nov. 22. “There will be more volatility.”
The government’s plan to open up state-controlled industries has gained some traction with investors. PetroChina Co.’s Hong Kong-listed shares have rallied 26 percent from an almost five-year low in February through yesterday as Chairman Zhou Jiping said the company may allow private investment in pipelines and gas exploration.
China Petroleum & Chemical Corp., the refiner known as Sinopec, surged 17 percent since announcing its intention to sell part of its oil-retail unit on Feb. 19.
A lack of details on some reform measures, such as the plan to allow cross-border stock trading through the Shanghai and Hong Kong exchanges, has deterred some investors, according to Edmond de Rothschild’s Gaud. While Hong Kong’s Hang Seng Index rose 1.5 percent on the day of the announcement, it has since fallen 3.6 percent through yesterday. The Shanghai Composite gained 1.4 percent, before declining 3.9 percent. Regulators said it may take six months to finalize the link.
Overseas institutions and investors will be able to trade shares on the SSE 180 Index and SSE 380 Index, as well as dual-listed stocks, via Hong Kong brokerages, Hong Kong’s government said April 10. Chinese institutions and investors with at least 500,000 yuan ($80,272) in their securities accounts will be able to buy Hong Kong shares using yuan, subject to quotas.
A previous plan to allow Chinese individuals to buy Hong Kong stocks announced in 2007 sparked a 49 percent advance by the Hang Seng Index over more than two months before the idea was shelved.
President Xi Jinping said in remarks published May 10 that the nation needs to adapt to a “new normal” in the pace of economic growth and remain “cool-minded” amid what analysts forecast will be the weakest annual growth since 1990. Xi is seeking to tackle threats to an economic boom now in its fourth decade, from mounting debt to air pollution that’s choking the nation’s cities.
“Political rhetoric has already changed with the ‘Chinese dream’ espousing better quality of life rather than faster development,” Francis Cheung, an analyst at CLSA, wrote in a report dated May 8. “China needs to de-lever from overinvestment, high debt, overcapacity, but new growth drivers such as urbanisation and consumption - are not ready to lead economic growth.”
Policy makers have realized the limits of monetary stimulus, Cheung said. The central bank last lowered benchmark lending rates in July 2012, while it cut the amount of cash that banks must set aside as reserves in May that year.
“The overriding factor in the short term is the slowdown in growth,” Erwin Sanft, head of China and Hong Kong equity research at Standard Chartered Plc, said in interview on May 12 in Hong Kong. “The market knows these things are positive but while the economy is slowing down, it’s hard to escape the fact that all the short-term data will be weak.”