Anyone who shorted Chinese stocks, went long the yuan and loaded up on the country’s government debt has unexpectedly won big in 2018.
Strategists across the board have been blindsided by China’s financial markets this year, where extreme moves mean the nation has hosted both the world’s best and worst performing assets all at once.
The Shanghai Composite Index is now 16% below December’s year-end targets, the 10-year bond yields 108 basis points less than forecast, and the currency is already stronger than almost all analysts had predicted.
Concern that a trade spat with the US will hurt China’s already-slowing economy has accelerated a flight to safety since late January, spurring investors to dump stocks that were trading at the loftiest valuations since 2015. Receding inflation risks and worse-than-expected data helped make bonds a relative haven, vindicating contrarians like Jean-Charles Sambor who has been bullish on China’s debt since yields peaked in November.
“Investors got wrong footed on China given they were expecting strong growth, inflationary pressures, and an aggressive deleveraging combined with potential monetary tightening,” said Sambor, who helps manage $3.7bn as BNP Paribas Asset Management’s deputy head of emerging-market debt in London. “Clearly, none of these materialised.”
There have been tentative signs this week that market behaviour could be shifting in China. But while equity investors on Tuesday applauded signs that the Communist Party is willing to ease its tightening campaign, stocks have since given back most of those gains.
The yuan isn’t far off the highest level since its 2015 devaluation, even as policymakers on Wednesday allowed more capital to flow out of the country. And although 10-year yields are up this week, they’ve still heading for their biggest monthly decline in almost two years.
The Shanghai Composite ended up 0.2% on Friday, after losing as much as 0.8% in earlier trading.
One-way bets are a common sighting in China, especially for stocks where crowded trades tend to unravel as quickly as they gather. For longer-term investors with a high threshold for risk, wading through the noise is a challenge that’s become all too familiar.
“Volatility is a function of China – its markets typically exaggerate moves one way or another,” said Howard Wang, who oversees JPMorgan Asset Management’s Greater China fund in Hong Kong. “You need to look through this and find companies which are doing really well. We think the right level for A shares is up a healthy double digits year to date.”
That’s a tall order for the mainland’s main equity benchmarks: the Shanghai Composite, the CSI 300 Index and the FTSE A50 Index are all down at least 6.5% for the year. The losses, as well as softening economic growth, prompted Morgan Stanley strategists to trim their index targets for China’s earlier this month.
Adding to the unease is the wall of institutional money that may be preparing to rotate out of equities and into safer assets like bonds, as China pushes ahead with its clampdown on leverage, according to Morgan Stanley strategists. Although delayed, new rules that will govern the country’s $16tn asset management products industry will focus on curbing risk and have probably caused some preemptive withdrawals, the strategists say.
“It’s hard to say just how much these recent movements in equity and bond prices reflect economic fundamentals and how much they reflect regulatory changes,” said Jonathan Garner, Morgan Stanley’s chief Asia and emerging market strategist in Hong Kong. “A clear set of April data will tell us where the economy is really heading.”
A pedestrian walks past the Shanghai Stock Exchange building in China. The Shanghai Composite Index is now 16% below December’s year-end targets, the 10-year bond yields 108 basis points less than forecast, and the currency is already stronger than almost all analysts had predicted.
