China’s Bear Market Lures Foreign Bids as Locals Pull Funds

International money managers are lining up to buy stocks in mainland China at a record pace, even as a third year of equity losses spurs local investors to empty trading accounts like never before.

While overseas firms were granted $6.9 billion of quotas to purchase mainland securities since December, more than in any full year since the government program began, the number of Chinese stock accounts containing funds dropped by 788,000 to 56.3 million in the year to Aug. 3, the most for a 12-month period. A record 110 million are empty or frozen, according to regulatory data compiled by Bloomberg.

Foreign funds from Taiwan Life Insurance Co. to Shinhan BNP Paribas Asset Management Co. say the 54 percent discount for companies in the Shanghai Composite Index to their 10-year average, and the lowest valuations relative to MSCI Inc.’s developing-nations measure make China shares irresistible. Local individuals, companies and institutions, which hold about 99 percent of mainland shares, are turning more bearish as the world’s second-largest economy slows.

“The value story is clearly emerging in China,” Kim Jun Sung, the chief investment officer for equities at Samsung Asset Management Co., which oversees about $100 billion and received a $150 million quota to buy mainland securities in 2010, said in an Aug. 7 interview in Seoul. “The economic outlook continues to be negative so the catalyst for growth is not yet there.”

State Support

At least 41 overseas institutions gained access to mainland stocks this year as China eased capital restrictions before a once-in-a-decade leadership transition in the ruling Communist Party. China Securities Regulatory Commission Chairman Guo Shuqing expanded the qualified foreign institutional investor, or QFII, program as part of a plan to restore confidence in the $2.8 trillion stock market.

The Shanghai Composite has tumbled 32 percent from its November 2010 high through yesterday, the most among benchmark equity gauges in 21 developing nations tracked by Bloomberg. PetroChina Co., the nation’s largest energy company, and Industrial & Commercial Bank of China Ltd., the biggest lender by market value, contributed most to the Shanghai Composite’s 631-day bear market, the longest in its two-decade history.

The gauge fell 1.1 percent to 2,118.95 at the 3 p.m. local-time close, extending its drop this year to 3.7 percent.

“We are keen on entering” China’s equity market, Chen Tai-shan, a Taipei-based vice-president at Taiwan Life, said by phone on Aug. 7. His company received a $100 million QFII quota in March and plans to invest as much as 60 percent of the money in stocks, favoring retailers and railways. “Shares have reached a bottom.”

Selling Out

The Shanghai Composite’s price-to-earnings ratio has dropped to 11.5 from an average 25 during the past decade and a 2007 high of 46, according to data compiled by Bloomberg. The MSCI Emerging Markets Index is valued at 12 times profit while the Bovespa index in Brazil, the second-biggest emerging market after China, trades for 14.6 times.

Falling valuations aren’t enough to entice Yao Lina, a 32-year-old accountant in Shanghai who sold all her stock holdings in February and withdrew 80,000 yuan ($12,580) from her trading account. She has no plans to invest in equities, saying the government may take as long as five years to fix “structural” challenges in the economy that have curbed growth.

“I have no confidence in the stock market,” Yao said by phone on Aug. 8.

Slowing Economy

Policy makers cut their expansion target to 7.5 percent from the 8 percent goal in place since 2005, Premier Wen Jiabao said on March 5. Wen, 69, is trying to reduce China’s reliance on exports and boost consumption as he hands power to a younger generation of leaders this year.

Gross domestic product rose 7.6 percent in the second quarter, the slowest pace since 2009. Retail sales growth fell to the lowest level since February 2011 last month, while industrial production expanded at the weakest rate in three years. The 1 percent increase in exports reported by the nation’s customs bureau on Aug. 10 trailed all 32 economist estimates in a Bloomberg survey.

Chinese industrial companies’ earnings fell for a third month in June, according to the government. Beijing-based Air China Ltd., the world’s second-biggest carrier by market value, said last month its first-half profit probably dropped more than 50 percent, while Tianjin-based China Cosco Holdings Co., the nation’s largest listed shipping firm, reported a loss.

Empty Accounts

As economic growth has slowed, the number of Chinese equity accounts that contained assets fell for 11 straight weeks through Aug. 3, the longest stretch of declines on record, according to the China Securities Depository & Clearing Corp.

Investors opened 322,851 new accounts to trade shares last month, the fewest since the clearing house began publishing the weekly data five years ago and down from a peak of 4.1 million in the four weeks to Sept. 21, 2007. The 110 million empty or frozen accounts are equivalent to about 8.5 percent of China’s 1.3 billion people and exceed the populations of Germany and the Philippines.

A gauge of sentiment towards Chinese stocks compiled by Credit Suisse Group AG, Switzerland’s second-biggest bank, sank for a third month in July, according to an Aug. 6 report. Seven percent of the 200 people surveyed said they invested in equities last month, compared with 27 percent who planned to purchase property.

Alternative Investments

Chinese real estate and fixed-income securities are luring residents from stocks as home prices rally and inflation slows. Yao used the proceeds from her share sales to help pay for a 400,000 yuan apartment.

Carrie Pan, a 29-year-old accountant in Shanghai who hasn’t purchased equities since April, plans to increase her 300,000-yuan holding of wealth-management products. The investments, comprised mostly of bonds and money-market securities, are arranged by banks and provide an average annual return of 4 percent, Pan said.

Wealth-management products in China were valued at 10.4 trillion yuan at the end of the second quarter, according to Fitch Ratings. The amount is about 60 percent of Chinese companies’ market value, data compiled by Bloomberg show.

Prices for Chinese homes rose for a second straight month in July, marking a “turning point” in the property market after nine months of declines, SouFun Holdings Ltd., the country’s biggest real estate website owner, said on Aug. 1.

Shifting Assets

An index of local-currency debt in China compiled by JPMorgan Chase & Co. has returned 2.6 percent this year as consumer price increases slowed to a 30-month low of 1.8 percent last month. The benchmark one-year savings deposit rate is 3 percent, the highest versus inflation since December 2009.

Pan is waiting for the Shanghai Composite to fall to 2,000, about 7 percent below yesterday’s closing level, before she considers adding to holdings.

Some local individuals and companies are moving assets overseas, Hao Hong, the Hong Kong-based managing director for research at Bocom International Holdings Co., said in an Aug. 7 phone interview.

China reported a capital-account deficit of $71.4 billion in the second quarter, the widest gap since at least 1998. Residents with at least 10 million yuan of assets surveyed by the Hurun Report have 19 percent of their holdings overseas, while more than 60 percent have emigrated or plan to leave the country in the near future, according to a July 31 statement from the Shanghai-based firm, which tracks China’s rich.

QFII Boost

“Local investors are seeing things the foreigners are not,” said Hong, the only strategist among 13 brokerages surveyed by Bloomberg at the start of the year to forecast declines for Chinese stocks in 2012. “There are structural issues in the economy that are hard to resolve.”

Policy makers are taking steps to revive confidence in the stock market and boost economic growth. Guo, the chairman of the CSRC, has reduced transaction fees on equity trades by 20 percent, urged listed companies to pay more cash dividends and changed how initial public offerings are priced. The government also more than doubled allotments under the QFII program in April to $80 billion from $30 billion.

“During the application, the government encouraged investors to put more into stocks,” said Stan Lee, the head of financial and investor relations at Taipei-based Shin Kong Financial Holding Co., which received a $100 million quota to invest in China in March. Shin Kong plans to put as much as 70 percent of the money in equities, Lee said by phone on Aug. 7.

Looser Restrictions

About 75 percent of total QFII assets are invested in yuan-denominated stocks, known as A shares, with the rest in bonds and deposits, according to a CSRC statement in April. There are 176 foreign firms with approval to buy securities under the QFII scheme, which was set up in 2002. Of those, 147 have been given a combined quota of $28.5 billion, State Administration of Foreign Exchange data as of July 20 show. That’s about 1 percent of locally-listed Chinese equities’ total market value, according to data compiled by Bloomberg.

“In the medium to long term, we believe the Chinese market is going to do very well,” Mark Mobius, the executive chairman of Templeton Emerging Markets Group, said in an e-mailed response to questions yesterday. Templeton has a $300 million QFII quota, according to SAFE data.

China has also loosened restrictions on the yuan, doubling its daily trading band in April. The government is promoting greater use of the currency in international trade and investment. Sales of yuan-denominated bonds in Hong Kong climbed 25 percent to 121.9 billion yuan this year, after quadrupling in 2011, according to data compiled by Bloomberg.

Growth Outlook

China’s central bank cut interest rates in June and July, the first reductions since 2008, and lowered lenders’ reserve requirement ratios three times since November to boost lending and support growth.

The economic expansion will accelerate in the second half of this year and into 2013 as the government’s stimulus efforts take effect, Goldman Sachs Group Inc. economists including Hong Kong-based Cui Li said in a research report this month. The measures will increase foreign confidence in the stock market, Shin Kong Financial’s Lee said.

China’s leaders have adopted “pro-growth” policies as they seek a smooth political transition following the suspension of former Chongqing Communist Party Secretary Bo Xilai from the ruling Politburo in April, Bill McCahill, a managing director at Religare Capital Markets in Beijing, wrote in an Aug. 2 report.

Murder Trial

Bo was stripped of his post after his former police chief fled to the U.S. consulate in Chengdu in February with evidence implicating Bo’s wife in the murder of a British businessman, according to U.S. officials briefed on the matter. Gu Kailai confessed to the crime during a seven-hour trial on Aug. 9, the state-run Xinhua News Agency reported. The court has yet to announce its ruling.

GDP will increase at an average annual pace of about 8.7 percent during the next five years, the second-fastest rate among the 70 largest economies after Iraq, according to April estimates from the International Monetary Fund. China has $3.2 trillion of foreign exchange reserves, the world’s biggest holdings, data compiled by Bloomberg show.

“China has a lot of firepower to respond to threats to long-term growth,” Julie Dickson, a London-based product manager for equities at Ashmore Investment Management Ltd., which has $60 billion of assets in emerging markets, said in a phone interview on Aug. 10. Ashmore has a $250 million QFII quota, according to Dickson.

Profit Projections

The Shanghai Composite may rally 25 percent in the next 12 months, according to more than 3,000 share-price estimates for companies in the index compiled by Bloomberg. Earnings will probably jump 32 percent during the period, compared with an 18 percent gain for the MSCI emerging-markets index, projections compiled by Bloomberg show.

ICBC, which traded at a record-low of 5.9 times reported earnings last month, may advance 23 percent in Shanghai, according to the average of seven analysts’ estimates. PetroChina, Asia’s largest company by market value, is poised to gain 14 percent, projections compiled by Bloomberg show. Both companies are based in Beijing.

“Most of the negatives are already priced in, and chances of further decline from the current level are low,” said Park Jae Wu, a Hong Kong-based fund manager at Shinhan BNP Paribas Asset Management, which received a $100 million QFII quota in March and favors consumer companies. “Once the Chinese government announces more aggressive measures to support the economy, the market’s recovery trend will set in.”

Pan, the Shanghai accountant, said she isn’t so sure after the value of her equity investments lost 30 percent since last year. “Stocks have never halted declines.”