June 16 (Bloomberg) -- The cost of hedging against losses in the largest Chinese exchange-traded fund in the U.S. has fallen to a record low on optimism that government stimulus will help sustain growth in the world’s second-biggest economy.
The iShares China ETF rallied for five weeks, gaining 10 percent in the longest streak in a year, while options pricing on the fund is indicating investors are less concerned about future losses. The Bloomberg China-US Equity Index of the most-traded Chinese stocks in the U.S. rose 2 percent last week for the biggest advance since February.
Chinese stocks are back in favor as growth in industrial output and retail sales accelerated in May while new bank loans exceeded analyst estimates. Policy makers have taken measures such as lowering reserve requirements for some banks, providing tax breaks and accelerating public spending to shore up an economy that expanded at the slowest pace in six quarters for the January-March period.
“The targeted easing over the past two months has kept a floor under growth and assuaged investors’ concerns about a hard landing,” Michelle Gibley, director of international research at San Francisco-based Charles Schwab Corp., which has about $2.35 trillion in client assets, said by e-mail on June 13. “Chinese stocks are pricing in a lot of bad news and we believe the risk/reward is favorable for owning Chinese stocks over the next 6-12 months.”
China’s gross domestic product is projected to expand 7.3 percent this year, which would be the weakest pace since 1990, according to a survey of analysts in May. Growth slowed to 7.4 percent in the first quarter from a year earlier, compared with 7.7 percent in the previous period.
The People’s Bank of China approved a half percentage-point cut to reserve-requirements for Industrial Bank and China Minsheng Banking Corp., spokesmen said in separate telephone interviews today. China Merchants Bank Co. also confirmed a half-point cut in a stock-exchange statement. Earlier this month, the central bank announced it was lowering the ratio to some regional banks to support small business and agriculture.
Puts hedging against a 10 percent decline on the iShares China ETF cost 0.94 point more than calls betting on a 10 percent increase on June 3, according to three-month implied volatility data compiled by Bloomberg. That’s the lowest level on record for the measure known as skew.
Implied volatility, used to track options prices, for the bearish contracts was 20.3 on June 13, compared with 18.7 for the bullish calls, the data show. Skew, or the spread between put and call implied volatility, has dropped about 5 points from a February high to this month’s low.
The iShares China ETF, which is invested in the largest Chinese companies traded in Hong Kong, has jumped 15 percent over the past three months. The Chicago Board Options Exchange China ETF Volatility Index, a measure of expected price swings, dropped 34 percent during the period.
The Shanghai Composite Index rose 0.7 percent to 2,085.98 today, the highest since April 18, while the Hang Seng China Enterprises Index was little changed in Hong Kong.
The Hang Seng gauge of the biggest Chinese companies capped a five-week rally last week. Its three-month gain of 13 percent compared with a 2.6 percent increase in the Shanghai Composite.
“The Shanghai Composite has lagged the ETF performance, indicating that sentiment has shifted more among asset allocators who want to quickly shift into the asset class rather than by longer-term oriented stock pickers,” Gibley at Charles Schwab said.
The ability of the government to revive the economy remains diminished amid the risk of inflating asset prices, according to Eric Lascelles, chief economist for RBC Global Asset Management.
“The government stimulus is still much more muted than we’ve seen in the past, which reflects reluctance to re-inflate credit bubbles,” Lascelles said in a phone interview from Toronto last week. “Policy makers are walking a tightrope, attempting to keep the economy going without encouraging further credit excesses. In my opinion, this will be hard to do.”
The Communist Party is trying to boost growth without repeating the mistakes of its $586 billion stimulus begun in 2008, which caused a record buildup of debt and inflated property bubbles. President Xi Jinping said earlier this year that the nation needs to adapt to a “new normal” in the pace of growth.
Fiscal policy measures announced in April should help authorities reach this year’s growth target, although most of the investments will be debt financed and likely add to imbalances and vulnerabilities, the World Bank said in a June report.
The Washington-based lender estimates the economy will expand 7.6 percent this year and 7.5 percent in 2015.
“Investors are becoming receptive to adding equity exposure to China in a measured way,” Neil Azous, founder of Stamford, Connecticut-based research firm Rareview Macro LLC, said in an interview on June 13. “China is being looked at closely and the iShares China large-cap ETF is an efficient and liquid proxy to express that view.”
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