Short Sellers Target A-Share ETF After Mainland Rally

Short sellers are growing more convinced that China’s world-beating equity rally is poised to end.

Short interest in the largest U.S. exchange-traded fund tracking mainland stocks was 6.3 percent of outstanding shares on Monday, up from just 0.1 percent at the end of last year, according to data compiled by Markit Ltd. and Bloomberg. The Deutsche X-trackers Harvest CSI 300 China A-Shares ETF rose 0.6 percent since Feb. 18, when Chinese markets closed for holidays. Mainland trading resumed Wednesday, after a 52 percent surge in the Shanghai Composite Index in the past 12 months.

Traders are boosting wagers on a decline in the ETF, which invests directly in local stocks, after monetary easing propelled Chinese shares to the best rally among major markets worldwide. Gains in so-called A shares have sent the Shanghai Composite’s valuation to a three-year high even as slower economic growth threatens to curb corporate profits and regulators take steps to cool the growth of stock purchases using borrowed money.

“We have been saying for several months that the speculation in the A-share markets was concerning and that the rise in stocks may have gone too far,” Michelle Gibley, director of international research at San Francisco-based Charles Schwab Corp., which has $2.45 trillion in client assets, said by e-mail. “Shorting the A-share ETF may be a reflection of this.”

Shorting Allowed

The Shanghai Composite slipped 0.4 percent to 3,234.08 at 10:23 a.m. local time, heading for the first retreat in eight days.

Short sellers are building positions in the ETF while bullish traders over the past two weeks stopped adding new money to the fund. The drought in inflows contrasts with the more than $400 million invested in the three months through January.

Overseas traders are using the U.S.-listed ETF for short sales against Chinese stocks because most have been prevented from betting on declines through local exchanges. That’ll change on March 2 when regulators start allowing international investors to conduct short sales through the city’s exchange link with Hong Kong.

The Deutsche Bank ETF rose to a four-week high of $36.41 on Tuesday in New York. The iShares China Large-Cap ETF, the largest ETF in the U.S. tracking Hong Kong-traded Chinese shares, added 0.8 percent in the five trading days during the mainland market holiday. A Bloomberg index of China’s most-traded stocks on American exchanges dropped 1.6 percent.

Market Tailwind

“I don’t see much upside in A shares for the rest of the year: valuations are not attractive,” Michael Wang, a strategist at Amiya Capital LLP in London, which invests in Chinese equities, said by e-mail Tuesday.

The Shanghai Composite trades at 12.3 times estimated earnings for the next 12 months, after reaching 12.7 last month, the highest level since 2011.

The number of shares borrowed and sold short to profit from a decline in Deutsche Bank’s A-share ETF was 1.8 million on Feb. 23. That’s close to the record of 2.4 million, or 8.2 percent of total shares outstanding, reached Feb. 13, data compiled by London-based Markit show.

While A-share valuations are no longer cheap, central bank measures aimed at boosting liquidity in the financial system, including a reduction in banks’ reserve requirements earlier this month, will be a “tailwind” to the local equity market, according to Jorge Mariscal, chief investment officer for emerging markets at UBS AG in New York.

“The liquidity injections benefit mostly the A-share market,” he said.

Manufacturing Growth

A Chinese manufacturing gauge rebounded in February, suggesting stimulus efforts and the U.S. recovery are supporting factories in the world’s second-largest economy.

The preliminary Purchasing Managers’ Index from HSBC Holdings Plc and Markit Economics was at 50.1, exceeding the median estimate of 49.5 in a Bloomberg survey and up from January’s 49.7. Numbers above 50 indicate expansion.

The rally in the Shanghai gauge pushed the premium on dual-listed shares in Shanghai to 22 percent last week, up from a discount in November, according to the Hang Seng China AH Premium Index.

The gain in the benchmark index for A shares since November “well surpasses” the increase in Hong Kong-listed shares of mainland companies, known as H shares, said Gibley at Charles Schwab. “We prefer H shares over A shares,” she said.

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