Big is huge

The Beautiful 50 Fly Close to the Sun

China's biggest companies are the new market darlings. For now.
Qilai Shen/Bloomberg

China's largest blue chips are flying high.

There's been a seismic shift in the notoriously speculative $8.7 trillion stock market. Large-cap blue-chip companies are the new darlings, a reversal from the smaller growth stocks previously in favor.

The Beautiful 50, a local term for the 50 most influential companies on the Shanghai Stock Exchange, returned 33 percent this year. The Shenzhen Composite Index, which tracks smaller, faster-growing companies listed on the southern exchange, is broadly flat.

China's Beautiful 50

The biggest blue-chips rallied this year, reversing years of underdog performance

Source: Bloomberg

As China prepares for inclusion in the MSCI global indexes next year, there's tentative evidence that the retail-oriented market is turning more institutional. According to Southwest Securities Co., professional investors now own on average one-third of the free float, compared with 20 percent in 2011.

Foreign investors helped, with net buying of $48 billion through the Shanghai-Hong Kong Connect system over the last three years. Unlike the retail investors who love small growth stocks, institutions prefer large-cap cash cows.

The traditionally lucrative bet on small stocks hasn't worked this year, according to Nine Martingale Investment Management LP, a Shanghai-based hedge fund set up by ex-UBS quants. A portfolio that bought the smallest 10 percent of companies in every industry and sold the largest 10 percent, rebalanced monthly, would have earned at least 12 percent a year since 2013. This year, that strategy would have resulted in an 8 percent loss.

Strategy Reversal

Buying small companies and selling the biggest worked well until this year

Source: Nine Martingale Investment Management LP

The Chinese government must be loving this. Of the Beautiful 50, only three are run by the private sector. The rest are either outright state-owned enterprises such as Kweichow Moutai Co., or "public enterprises" like Ping An Insurance Group Co., which counts sovereign wealth funds as major shareholders. Imagine the billions of wealth created!

Going institutional doesn't necessarily mean the market is becoming more rational, however.

In the past, what went up also came down, the most famous example being the plunge in the CSI 300 Index from 5,300 in June 2015 to 3,660 just one month later. A sector-neutral portfolio that bought the biggest losers and sold the biggest winners in the previous month was an outstanding money-making machine. In the 12 months from July 2015 through June 2016, that strategy would have given you a 43 percent return.

This year, there's no reversion to the mean. Following the same strategy, you would have been down 1.8 percent.

What Goes Up...

...didn't come down this year, so the strategy of buying underdogs failed

Source: Nine Martingale Investment Management LP

As institutional money is continuously chasing large-cap, stable growth companies, both the size and reversal strategies have failed, according to Nine Martingale portfolio manager Rosalin Wu. 

Can the Beautiful 50 defy gravity? The Chinese government is clearly worried. 

On Monday night, the Shanghai Stock Exchange rebuked the publisher of a bullish report on Kweichow Moutai, days after the official Xinhua News Agency said shares of China's biggest liquor maker should rise at a slower pace. Moutai has more than doubled in value this year to become a $127 billion giant.

Unlike the usual terse exchange utterances, this one was detailed. For example, it questioned a price assumption of 1,299 yuan ($196) per bottle used by Essence Securities Co., the researcher, saying Moutai costs only 819 yuan at the wholesale level.

Meanwhile, the broader Chinese market isn't healthy. A little more than 10 percent of mainland stocks are trading above their 100-day moving average, against 88 percent of those in the Topix Index and 77 percent of India's Sensex. 

Slaps on the wrist probably won't change much. While Moutai's shares sold off after the Xinhua article, other favorites more than made up the difference. Ping An Insurance, the biggest of the Beautiful 50, is now the world's second-largest insurer by market value after Berkshire Hathaway Inc., following a 121 percent year-to-date rally.

China favors so-called window guidance, where the government suggests trading positions to the industry. In 2015, funds weren't allowed to sell. Will it soon be time to tell them not to buy?

(Corrects size of market in second paragraph.)
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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    Shuli Ren in Hong Kong at

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