China Bears on Wrong End of $4 Trillion Rally Refuse to Go Away

China's Stock Market
Investors observe stock market at a stock exchange corporation on April 7, 2015 in Huaibei, Anhui province of China. Source: ChinaFotoPress via Getty Images

Bull markets are always tough on short sellers. This one in China right now, though, is proving downright brutal.

Bearish wagers on the Shanghai Stock Exchange have climbed more than threefold in the past nine months and reached a record 7.46 billion yuan ($1.2 billion) on Thursday, a period in which the benchmark equity index jumped 94 percent. Across the border in Hong Kong, where the Hang Seng Composite Index has surged 7.6 percent in just the past two days, the gauge’s 20 most-shorted stocks surged 18 percent on average.

The gains show the dangers of betting against a Chinese market where new investors are flocking to stocks at a record pace and traders have taken out an unprecedented 1.06 trillion yuan of debt in Shanghai to amplify their buying power. While technical indicators show shares in both the mainland and Hong Kong are more vulnerable to a reversal than any other market, Marco Polo Pure Asset Management says bears may be setting themselves up for more losses if China’s stimulus efforts produce an economic recovery later this year.

“It’s not a market you want to bet against,” said Aaron Boesky, who oversees about $125 million as the chief executive officer of Marco Polo in Hong Kong. The firm’s Pure China fund was the top performer in the second half of 2014 among China-focused hedge funds tracked by AsiaHedge Intelligence.

“I can respect people who might want to stay out of it, because it is a very volatile market, even for local Chinese,” he said. “Staying out is respectable. Shorting it could be suicidal.”

Brokerage Shorts

The Shanghai index rose 1.9 percent at the close on Friday, while the Hang Seng Composite climbed 0.7 percent to the highest level since January 2008.

Short sellers, who borrow shares and sell them in a bet they’ll be able to buy back the stock later at a lower price, have been stepping up their wagers in Shanghai as the city’s stock index jumped to a seven-year high.

Industrial & Commercial Bank of China Ltd., the nation’s biggest lender, and China Everbright Bank Co. are among shares with the highest short positions. ICBC has jumped 45 percent in the past 12 months, while China Everbright Bank surged 102 percent.

In Hong Kong, short sellers have been targeting brokerages after the shares surged at the end of last year on bets profits will increase amid record trading.

ETF Bets

Instead of tumbling, the stocks have extended gains this week to record highs. China Galaxy Securities Co., which has about 13 percent of its outstanding shares sold short, jumped 38 percent in the past two days, according to data compiled by Markit Group Ltd. and Bloomberg. Haitong Securities Co., the nation’s third-largest brokerage by market value, has climbed 28 percent even after short interest increased to 8.9 percent from 0.3 percent 12 months ago.

U.S. short sellers have also been betting against the China rally. Bearish bets on the Deutsche X-trackers Harvest CSI 300 China A-Shares exchange-traded fund have climbed from about 0.1 percent of the outstanding shares at the start of this year to 7.3 percent as of April 7, according to data compiled by Markit and Bloomberg.

In China, short wagers still represent a small proportion of the nation’s stock market, which has surged by almost $4 trillion in less than a year to $7 trillion in market value. Some of those bets may also come from pair trades, such as shorting mainland shares to buy cheaper counterparts in Hong Kong or taking a long position in a futures contract to exploit short-term price differences, according to Hao Hong, the chief China strategist at Bocom International Holdings Co. in Hong Kong.

Valuations Rise

Valuations in China are so high that bears may eventually prove correct, according to Marcus Liu, a Hong Kong-based analyst at CLSA Ltd.

“It’s very hard to time the correction but I would say that it can happen very quickly,” Liu said. “Chinese shares are very much in the bubble territory at the moment.”

The Shanghai Composite trades for about 15 times estimated earnings for the next 12 months, versus the five-year average multiple of 10. Relative strength indexes for benchmark gauges in Hong Kong and China have both exceeded 80 this week, the highest among global equity measures tracked by Bloomberg and above the 70 threshold that some traders view as a sign that gains have gone too far, too fast.

Chinese Buyers

There’s little sign of a slowdown in stock buying on the mainland, said Chen Xiaofei, an investment consultant at Changjiang Securities Co. in Shanghai. Most of the firm’s clients are bullish and the brokerage has been lending out nearly all of its funds available for margin purchases during the past few days, Chen said.

Mainland buying is also spilling over into Hong Kong through the city’s exchange link with Shanghai. Buy orders for shares in the former British colony via the connect reached the maximum 10.5 billion yuan ($1.4 billion) limit during the past two days.

Bears may not have the staying power to capitalize on a meaningful selloff, according to Wei Wei, an analyst at West China Securities Co. in Shanghai.

“Personally, I don’t think it’s a good time to short stocks now,” Wei said.

(An earlier version of this story corrected the level of the short-sale record in Shanghai.)

— With assistance by Shidong Zhang, and Allen Wan

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