China Bears Miss Worst Selloff Since 2008 After Cutting Short Bets

CHINA-STOCKS

Investors look at screens showing stock market movements at a securities company in Beijing on January 7, 2016. Chinese markets were suspended on January 7 for the second day this week after they fell more than seven percent, leading an Asia-wide sell-off as China weakened the value of the yuan currency by the most since August. AFP PHOTO / FRED DUFOUR / AFP / FRED DUFOUR (Photo credit should read FRED DUFOUR/AFP/Getty Images)

Photographer: Fred Dufour/AFP via Getty Images
  • Short interest in A-share ETF down about 90% before China rout
  • Trading shows difficulty of timing China's volatile markets

Talk about mistimed trading: Bears on Chinese equities just missed the biggest sell-off in seven years.

Short sellers abandoned their bearish bets against the biggest A-share ETF listed in the U.S. just as mainland stocks tumbled the most in January since the global financial crisis.

Shares borrowed and sold on expectations of a decline in the exchange-traded fund fell to a one-year low of 4.2 percent of stock outstanding on Jan. 11, down from a record of 38 percent on Dec. 9, according to data compiled by Bloomberg and Markit. The trades were unwound as the fund, which tracks the CSI 300 Index of companies traded in Shanghai and Shenzhen, lost as much as 28 percent from a peak in late 2015 through last week.

Traders gave up on their bearish wagers on the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF in December after losing money during a four-month rally fueled by speculation policy makers would add new stimulus measures following a $5 trillion August stock rout. Scaling back on the short sales backfired when signs of weakening growth and surging capital outflows from China combined with a failed circuit-breaker program triggered mainland markets’ descent into a bear market in January.

Missed Opportunity

“You did see a lot of people missed the selloff,” Drew Forman, co-head of trading at Macro Risk Advisors LLC, a brokerage of equities and options, said by phone last week from New York.

The combination of changes in investors’ outlook on China’s stock markets and the high cost to borrow the ETF for bearish trading may have contributed to the drop in short interest, according to Dodd Kittsley, head of ETF strategy and national accounts in New York at Deutsche Asset and Wealth Management.

The cost to borrow the ETF to short it reached a high of 10 in December, the most expensive level on a scale provided by Markit, a London-based research firm. It’s currently rated 7. Investors pulled $46 million from the fund in the three weeks through Jan. 29, helping cut total assets to about $300 million.

“From our understanding, the changes of short interest are driven by the changes of shares outstanding, sentiment around China and the borrowing cost,” Kittsley said.

Bears Return

Bearish traders are returning to the fund now. Short interest in the ETF has more than doubled in the past two weeks to 8.9 percent of shares outstanding, the data show. The fund fell 5.4 percent to $22.17 in the five trading days through Jan. 29, trading near a 14-month low. The benchmark Shanghai Composite Index fell 23 percent in January, the most since October 2008.

Betting against the ETF has been a profitable trade in the past. Short sellers in the U.S.-listed ETF were rewarded seven months ago after more than doubling their bearish wagers in the two weeks leading up to the peak in June. Short interest reached 15 percent of shares outstanding the day the market topped out on June 12, a record at the time. The ETF and the Shanghai Composite both fell more than 40 percent in the subsequent crash, a selloff that was only halted after the government’s intervention.

China’s financial markets have become notoriously volatile and difficult to forecast amid a string of government interventions, according to Wayne Lin, New York-based money manager at QS Investors LLC, whose firm oversees $18 billion assets including Chinese stocks.

“China is still a semi-closed speculative market,” said Lin, “It’s very hard for the underlying value to drive the investment decisions.”

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