Futures Belie Bulls After China Stock Gauge Rallies 11%

Traders in Chinese stock-index futures are sending a bearish signal after benchmark gauges surged to the highest levels in seven months.

The number of transactions for contracts on China’s CSI 300 Index fell yesterday to the lowest level in 10 months versus share volumes in the cash market, data compiled by Bloomberg show. The last two times the ratio fell this low, in September and February 2013, the CSI 300 sank an average 8.2 percent over two months.

China’s most sophisticated traders favor futures because the contracts make it easier to add leverage to high-conviction wagers, Hao Hong, the Hong Kong-based strategist at Bocom International Holdings Co., said in an interview. While the highest equity volumes since 2010 show increased confidence among individual investors in China’s economic expansion, the lack of interest from futures traders is a sign the recovery is already reflected in stock prices, Hong said.

“The probability for at least a correction, even if not sizable, is very high,” Hong said yesterday. “The recovery has long been a consensus and is already in the price.”

Bocom International Holdings is a unit of Bank of Communications Co., China’s fifth-biggest lender.

‘Herding Effect’

Hong’s pessimistic view puts him at odds with bulls, including Standard Chartered Plc’s Erwin Sanft and Templeton Emerging Markets Group’s Mark Mobius, who say the rally will extend as low valuations lure investors and the government supports growth with stimulus. The CSI 300 surged 2.8 percent yesterday to 2,323.9, the highest since Dec. 31., extending its gain from a five-year low in March to 11 percent. The CSI 300 gained 0.3 percent by the close today, while the Shanghai Composite Index added 0.2 percent.

Trading of CSI 300 companies rose to about 18 billion shares yesterday, the highest level since October 2010, and has climbed about 73 percent since the gauge began rallying from its March low, data compiled by Bloomberg show. That compares with a 15 percent drop in trading of CSI 300 futures during the same period, to about 991,000 contracts.

When volumes in the futures market were this low relative to cash equities in February 2013, it came two days before the peak of a bull market in the index.

“We attribute the recent market rally as a typical herding effect,” Lu Wenjie, a strategist at UBS AG in Shanghai, said by phone yesterday.

Stimulus Measures

Individual investors account for about 80 percent of equity trading on the Shanghai Stock Exchange, versus about 14 percent on U.S. bourses, according to data compiled by the Chinese exchange and TABB Group LLC.

Bullish investors see the combination of government stimulus and reform lifting Chinese stock valuations from some of the lowest levels in emerging markets.

Mobius, whose $12 billion Templeton Asian Growth Fund has outperformed 93 percent of peers this year, said last week that he sees Chinese stocks rising an additional 20 percent. Sanft, the Hong Kong-based head of China and Hong Kong equity research at StanChart, predicts the rally will continue through year-end.

China cut reserve requirements for some banks, accelerated infrastructure spending and loosened property curbs as Premier Li Keqiang seeks to keep growth from falling below his 7.5 percent target. State-owned companies such as PetroChina Co., the nation’s largest energy firm, and Industrial & Commercial Bank of China Ltd., the top lender by market value, have been among the biggest contributors to the rally as the government pledged to open state-run industries to private capital.

Relative Value

The CSI 300 index is valued at 8.6 times estimated earnings for the next 12 months, versus a multiple of 12 for the MSCI Emerging Markets Index, according to data compiled by Bloomberg.

“China is up for a re-rating, quite a significant one,” said David Gaud, a Hong Kong-based senior portfolio manager at Edmond de Rothschild Group, which oversees about $179 billion. “They managed to combine both reforms and maintaining a certain momentum in the economy, which would be the perfect pair if it works.”

While valuations are low relative to peers, they’ve gotten more expensive during the past four months. The CSI 300 now trades at about a 1 percent premium versus its one-year average, and is approaching the three-year mean multiple of 9.5, data compiled by Bloomberg show.

The CSI 300’s gain lifted its 14-day relative-strength index to 80.9, the highest level since October 2010, as of yesterday. In the Shanghai Composite, 256 of the 1,004 members had an RSI of more than 70, the most since Nov. 23, 2009. The Shanghai gauge fell 29 percent from that level through July 5, 2010. Readings above 70 are a signal to some traders that the rally has gone too far, too fast.

“Investors should start reducing risk,” Hong wrote in a note to clients yesterday. “There will be another entry point.”

— With assistance by Allen Wan

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