China Stock Rally Spreads to Shanghai as Confidence Rebuilds

Updated on
  • Shanghai Composite Index has best two-day gain since March
  • Hang Seng China Enterprises Index erases this year’s decline

What's Driving China's Stock Rally?

China’s stock rebound is shifting up a gear.

A rally that started in Hong Kong-listed equities is spreading to the $6.3 trillion mainland market, where Shanghai’s benchmark gauge just posted its best two-day climb since March and the Shenzhen Composite Index is at an almost three-week high. Trading volume jumped on Monday amid broad gains that saw 90 stocks advance for each that fell.

Chinese shares --- whether listed at home, in Hong Kong or in the U.S. -- are among the world’s best performers in August as fears of a hard landing in the world’s second-largest economy recedes and the yuan stabilizes. With technical indicators flashing a warning that the rally may be overheating, HSBC Holdings Plc is still bullish.

“The international mood on China is improving," said Herald van der Linde, the Hong-Kong based head of Asia Pacific equity strategy at HSBC. “Investors are still substantially underweight on China. In that sense there’s much more to go."

The Shanghai Composite Index climbed 2.4 percent on Monday, extending Friday’s 1.6 percent advance and closing above its 200-day moving average for the first time in a year. Shares were lifted by speculation merger activity in the real estate industry will increase and the central bank will add to stimulus. Stocks in Shenzhen and Hong Kong also gained after the securities regulator said a long-delayed exchange link between the two cities will start in 2016.

The Hang Seng China Enterprises Index rose 1.6 percent on Monday to its highest level this year. The measure has rallied 8.4 percent this month, the best performance among 94 global gauges tracked by Bloomberg, while the Bloomberg China-US Equity index has jumped 8.3 percent and the Shanghai measure has increased 4.9 percent. The MSCI All-Country World Index is up 1.2 percent.

Foreign investor bullishness toward Chinese stocks is a sharp reversal from earlier in the year. Back in February, the H-share gauge was trading at the weakest level since 2009 and valuations were the lowest ever as concern over China’s economic slowdown and heavy-handed state intervention in mainland financial markets spurred outflows.

“Overseas investors were very wary of China and now that they’ve seen more evidence that the macro economy is stabilizing, it’s given them the confidence to come back to the China market," said Geoff Lewis, Hong Kong-based senior strategist for Asia at Manulife Asset Management.

Net buying of Shanghai shares via the Hong Kong exchange link jumped to the highest in in almost a year on Tuesday. The Shanghai Composite dropped 0.5 percent, while the Hang Seng China Enterprises Index edged lower for the first time in nine days.

Credit Growth

Data last week painted a mixed picture for the nation’s outlook. While factory-gate deflation eased for the seventh month, signaling improving conditions for manufacturers, industrial output, retail sales and investment all missed estimates. The broadest measure of new credit rose the least in two years, helping send the yield on China’s 10-year sovereign debt to the lowest in at least a decade as investors bet the central bank will ease monetary policy to spur growth.

The rally in the nation’s shares is starting to look overheated. The H-share index’s relative strength index has risen to 76, the highest since April 2015, while the Shanghai Composite’s has climbed to 70 -- the level that signals to some traders that shares are due to drop.

For Steven Leung, executive director at UOB Kay Hian (Hong Kong) Ltd., further gains in Shanghai will be limited.

"After the Shanghai index goes up another 5 to 8 percent to near 3,300 we will probably see quite a bit of selling pressure," Leung said. "Fundamentals, whether the economy or corporate earnings," aren’t improving, he said.

Index Correlation

Mainland shares still lag behind their Hong Kong counterparts. The Shanghai Composite remains down 12 percent this year, among the world’s biggest losers, compared with a 0.5 percent advance for the Hang Seng China Enterprises gauge. The two indexes were the least correlated since 2007 as of last week, according to data compiled by Bloomberg, while the Shanghai measure was at the lowest level relative to the H-share gauge since October.

Chinese stocks have room to rise further as waning bets for increased borrowing costs in the U.S. boost the attraction of riskier assets and the start of the Shenzhen-Hong Kong exchange link lures funds, according to Tony Chu, a Hong Kong-based money manager at RS Investment Management, which oversees about $17 billion.

"There’s a certain amount of catch-up to do, given H shares have done well," Chu said.