China Stocks Will Only Get Wilder After July Whipsaws Investors

(Bloomberg) -- Even by China’s standards, July was a wild month for its stock market.

A gauge of Shanghai’s large caps had its best day in five years, while Shenzhen’s high-priced tech firms briefly became the world’s hottest stocks. Turnover exceeded 1 trillion yuan ($143 billion) for 17 consecutive days, something that hadn’t happened since 2015. Kweichow Moutai Co., the country’s largest stock, set seven new all-time highs in July before losing a record $25 billion in a day.

While no single trigger explains why Chinese stocks took off when they did, bullish commentary from state media encouraged retail traders to lever up and pile into the market. And even though Beijing used some of its favorite tools to try to cool the fervor, the fear of missing out is so extreme that Chinese hedge funds sold about 1,500 new products in July alone.

The volatility is set to continue into August. China’s ambitions for a slow bull market will be tested by soaring tensions with the U.S. The biggest reform in years to onshore equity trading will come into effect, widening potential price swings for some stocks.

Traders will also be looking for further confirmation that the economy’s steady recovery from the coronavirus outbreak is continuing. The yuan strengthened the most since early July after data released Friday showed China’s manufacturing outlook improved for a second month. Stocks gained, with the CSI 300 Index closing 0.8% higher. The nation’s 10-year government bond futures slipped to a two week low.

Here’s a look at the factors that may influence China’s stocks and bonds in August:

ChiNext reform

China said in June that stocks listed in the tech-heavy ChiNext board in Shenzhen will no longer be subject to a daily price limit in the first five trading sessions. The first batch of share sales under the new rules will likely start trading in August. When that happens, every stock listed on the ChiNext will be allowed to rise or fall as much as 20%, compared with the current 10% daily cap.

China-U.S. tensions

A fresh escalation of tensions between the world’s two largest economies saw panic selling grip Chinese stocks last week, in a reminder of how quickly sentiment can sour. Traders based beyond mainland China sold more than $2.3 billion worth of Chinese stocks on Friday last week, one of the largest ever outflows via Hong Kong’s exchange links. There will be more twists and turns before the presidential elections, making the market more volatile, said Kinger Lau, chief China equities strategist at Goldman Sachs Group Inc.

Economic recovery

Traders will be seeking fresh signs that China’s economic recovery is on track. It returned to growth in the second quarter, marking an important milestone in the global struggle to climb out of the slump brought about by the pandemic. “The Chinese economy is recovering gradually, notwithstanding sporadic outbreaks in different parts of the country,” said Tai Hui, chief Asia market strategist at JPMorgan Asset Management. “Consumer confidence should also pick up as economic growth returns. We remain constructive on Chinese equities in the next 6-12 months.”

The PBOC

The People’s Bank of China has become more cautious when it comes to providing liquidity. While it wants to encourage lending so that companies can stay alive and grow, it wants to ensure such funds aren’t inflating risks in the financial system. The central bank drained the most cash this year in July, according to Bloomberg calculations based on maturities and injections of policy loans.

As this leads to costlier funding for companies, the PBOC may be tempted to loosen policy again in the coming months, according to Sun Lu, a strategist for Citigroup Inc. “We believe liquidity tightening is behind us,” she said. “A reserve-requirement ratio cut remains on the table in the second half.”

Bond supply

The prudent approach by the PBOC has been bad news for sovereign notes, which became collateral damage in July’s stock surge. Already under pressure from a surge of issuance, China’s 10-year government bonds are set for the longest run of monthly declines since 2018. Yields will likely move higher in August, given banks will need to set aside cash to buy new debt. The central and local governments and policy banks are expected to sell 600 billion yuan of bonds in August, according to Xing Zhaopeng, a markets economist at ANZ Bank China Co. That will be significant enough to hurt the fixed-income market, he added.

©2020 Bloomberg L.P.