Chinese Emboldened by 150% in Stock Returns Ignore Bonds

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Li Feixiang, who has bet all his money on Chinese stocks that returned more than 150 percent in the past year, scoffs at the 4 percent yields on AAA corporate bonds.

“I can’t settle for low returns,” said Li, a finance industry worker from Chengdu who has some 100,000 yuan ($16,120) left in his savings account after investing more than 2 million yuan in shares. “I’m not interested in bonds. It doesn’t make sense to put my money elsewhere when the stock market is going through a super bull run.”

Individual investors like Li, who account for 80 percent of trading in China’s 9.7 trillion yuan equities market, help explain why, in the face of a slowing economy, the Shanghai Composite Index breached 5,000 for the first time since 2008 on Friday. They’re ignoring bonds and pulling money out of funds that buy them, even as the securities decline to the cheapest levels relative to stocks in five years.

Flagging demand couldn’t come at a worst time as the debt market braces for municipal bond issuance of 1.77 trillion yuan this year, four times as much as in 2014. Net sales of corporate notes slumped 29 percent to 535 billion yuan in the first four months, just as a slowing economy makes it harder to repay liabilities and authorities allow the first onshore defaults.

Stocks Lead

The earnings yield for shares in the Shanghai Composite Index was 0.35 percentage point lower than the 4.32 percent average yield on top-rated five-year corporate bonds as of Friday, the least attractive since December 2009, according to data compiled by Bloomberg.

The Shanghai benchmark has surged 151 percent in the past year, dwarfing a 7.8 percent return on debt included in the ChinaBond Composite Total Return Index, while returns coupled with reinvested dividends came in at 157 percent. The gauge rose for a third day to 5,098 as of 1:11 p.m. Monday.

Chinese investors opened an unprecedented 4.44 million new stock accounts in the week ended May 29, according to data from the China Securities Depository & Clearing website. Equity fund assets jumped 84 percent to 1.77 trillion yuan in the year through April 30, while bond funds’ rose 34 percent to 359 billion yuan, data from the Asset Management Association of China showed.

While retail investors dominate China’s stock trading, commercial banks accounted for 62 percent of ownership in the interbank bond market as of May, according to ChinaBond data. This means that when people take money out of deposits and bank wealth products, demand for debt takes a hit.

“This year, we’ve really seen a seesaw effect,” said Cici Wang, a fixed-income analyst at Citic Securities Co. in Beijing. “When stocks rise more quickly, many bond funds and wealth-management products face redemption pressures.”

Bond Headwinds

The bond market has faced other headwinds as well, with supply set to soar as China moves to reduce local government borrowing costs. Municipal authorities will issue 1.77 trillion yuan of debt this year, which will include securities that will be exchanged for at least 1 trillion yuan of maturing high-cost borrowings. China will raise the swap quota by another 1 trillion yuan, according to people familiar with the matter.

“Investors’ enthusiastic chase for newly issued shares has diverted funds from bonds,” China International Capital Corp. analysts led by Chen Jianheng wrote in a June 1 report. “And as local governments will issue more debt in June than in May, the bond market may not be as bullish this month and yields might increase.”

IPO Frenzy

New share sales by 23 companies in the five days through June 5 were forecast to attract 4.9 trillion yuan of bids, a Bloomberg survey showed. Shares of the 144 firms that went public this year have jumped an average 532 percent so far, including a 44 percent increase on the first day of trading, the maximum amount allowed by local bourses.

“It’s better to embrace the stock market bubble than be afraid of it,” said Jeffrey Qi, who helps oversee about 30 billion yuan as a money manager at E Fund’s Hong Kong unit. “The Shanghai rally will continue due to the central bank’s easing, and there’s no need to cash out anytime soon.”

Valuations such as earnings yields or price-earnings ratios are not really applicable to China’s stock market, said James Yip, a fund manager at Shenwan Hongyuan Asset Management (Asia) Ltd. in Hong Kong.

“China’s stock market is liquidity-driven and policy-related,” Yip said in an interview on June 1. “Under such circumstances, stock investors’ mind-sets are not that rational. They don’t look at PEs, the earnings are meaningless.”

State Support

While Bill Gross, who oversees an unconstrained bond fund for Janus Capital, declared on Twitter June 3 that shares on the Shenzhen index are the next big trade for short sellers, China’s state media showed support for the stock market. The bull run won’t change and any adjustments will support further development, Xinhua News Agency said in an editorial May 28.

“The Shanghai Index will hit 6,000 this year,” said Li form Chengdu, half of whose investment in stocks was funded by loans from a brokerage firm. “Probably some big institutions hold bonds to lower risks, but I don’t think individual investors like me have to when the current market conditions are so good.”

— With assistance by Tian Chen, and Justina Lee

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