China Rally Is Just an Opportunity to Sell for Many Global Funds

The nascent rebound in Chinese shares is at risk of becoming yet another false dawn as foreign investors seem unconvinced that policymakers can revive a faltering economy.

(Bloomberg) — The nascent rebound in Chinese shares is at risk of becoming yet another false dawn as foreign investors seem unconvinced that policymakers can revive a faltering economy.

US and European long-only fund managers were net sellers of Chinese and Hong Kong stocks in July, according to Morgan Stanley, which is now advising clients to take profits on the recent rally and has downgraded China to equalweight. The FTSE China A50 Index is the only one of 10 major global benchmarks tracked by Citigroup Inc. on which investors had a short position end-July.

That’s even as key indexes in China and Hong Kong capped their best month since January after the Politburo meeting, where top leaders signaled more support for the troubled real estate sector alongside pledges to boost consumption. The Hang Seng China Enterprises Index, which tracks major Chinese shares listed in Hong Kong, climbed in afternoon trading on Thursday. Still, the gauge is down for this week amid a risk-off global backdrop, following its 6.1% surge over the previous five sessions.

“We have seen this before — strong rally not holding up,” said Michael J. Oh, a San Francisco-based portfolio manager at Matthews Asia. “I don’t think most global funds are really buying into China in any meaningful way yet,” he said, adding that the recent rebound is more a result of investors reversing their bearish bets.

READ: Hopes Run High for Chinese Stocks as Beijing Targets Consumption

Beijing is fighting an uphill battle in trying to revive an economy that has continued to lose steam, but for now has offered more words than action. It vowed to boost consumption and support private enterprises, but stopped short of handing out cash to families or offering tax breaks to businesses. Officials asked localities to roll out policies to stabilize the property market but provided no details.

“The July Politburo meeting signaled policy easing, but key issues including LGFV debt, the property and labor markets and the geopolitical situation need to improve significantly, in our view, for sustainable inflows and further re-rating,” Morgan Stanley equity strategists including Jonathan Garner and Laura Wang wrote in an Aug. 2 note.

“We believe investor confidence and conviction level are still very fragile, and that investors are still reluctant to pre-position in a major way, given that they have been disappointed by rather lackluster/lukewarm easing measures seen since March,” MS strategists wrote.

READ: US Buyers Shy Away From China Inc. With No Regrets: China Today

US-domiciled funds’ underweight positions on China are estimated to be at $25 billion in market value, accounting for 2.4% of the assets under management. For EU-domiciled funds, such positions are estimated to be at $5.9 billion and 1.2% of AUM, according to a separate MS quantitative strategy note.

‘Can’t Just Talk’

While global fund managers remain cautious, some may consider paring their underweight positions because sentiment has been bearish and valuations have fallen, said Vivian Lin Thurston, Chicago-based partner and portfolio manager at William Blair Investment Management LLC.

Priced at less than 11 times forward one-year earnings, the MSCI China Index is below its five-year average multiple of over 12 times. It’s valued at a 14% discount versus the MSCI Emerging Markets Index, compared with the average 4% discount since 2010.

Thursday’s gains came as a private survey showed China’s services activity expanded at a faster pace than expected in July. The positive reading is a welcome sign for the services industry, which has held up during an otherwise troubled post-pandemic recovery for China. 

Separately, China’s central bank may cut the reserve-requirement ratio for major banks as soon as this month in an effort to boost lending and revive momentum for the economic recovery, according to several analysts.

READ: Chinese Stocks Rebound in Afternoon Trading; Brokerages Rally

From here, investors will likely need to see authorities making lending to businesses easier and supporting the housing market before turning more bullish, William Blair’s Thurston said. “Some money and fiscal incentives need to come through. You can’t just talk without the monetary support.”

Thurston said investors should focus more on stock picking due to uncertainties around stimulus and macro policies. She favors sectors less prone to weak consumer sentiment, including liquor, internet and athletic footwear.

Meanwhile, the lack of concrete measures has only intensified concerns that China’s economic problems have no quick fix, making a sustainable equity rebound harder to come by.

“Our recommended strategy is selling into strength on any announcement that is going to create some optimism,” said Arthur Budaghyan, Montreal-based chief emerging markets strategist at BCA Research Inc. The stock rally won’t last long “because eventually, the business cycle and corporate profits will disappoint again,” he said.

READ: China’s Reluctance on Stimulus Will Cap 2023 Growth

–With assistance from George Lei.

(Adds data on funds’ positions in the ninth paragraph.)

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