China Stock Rebound Leaves Market Divided on Limits to Crackdown

(Bloomberg) -- Strategists were split on efforts by Beijing to calm China’s volatile financial markets, cautioning on the robustness of Thursday’s equity rebound while staying positive on the nation’s government bonds. The yuan was expected to remain under pressure.

A deepening selloff in Chinese stocks spread to global bond and currency markets this week after Beijing’s months-long regulatory onslaught on private enterprise intensified. The moves reversed somewhat Thursday after authorities sought to calm fears that a crackdown on the education industry will spill into other industries.

“It is likely that both the intensity and tone of the recent regulatory crackdown will be lessened,” said Gavekal Research analyst Thomas Gatley. “That does not mean that the campaign to comprehensively regulate internet platforms will be abandoned as it remains a high-level political priority.”

Here’s a look at how Chinese assets stand after a volatile week:

Equity Bears

The crackdown pushed China’s benchmark CSI 300 Index close to a bear market -- something the coronavirus failed to do -- for the first time since worries about a trade war in 2018. The gauge closed down 18% from its year-to-date high on Tuesday before paring losses on Wednesday and Thursday.

“The regulatory storm can shrink to a more manageable size which, given the beaten-down valuations of Chinese tech firms, should create plenty of buying opportunities,” said Gatley.

Nascent Rebound

Launched just a year ago, the Hang Seng Tech Index saw record swings to the downside then up this week. The gauge of many Hong Kong-listed Chinese stocks booked its biggest loss since inception on Tuesday as rumors swirled of foreign outflows, before rising the most ever on Thursday after Beijing’s attempts to soothe investors. The rebound is very much tentative -- it still has a ways to rise before its first real technical test.

“We don’t expect sentiment will be restored completely in the short-term due to a low visibility on policy, especially for internet-related companies,” said Mark Po, a Hong-Kong based analyst with China Galaxy International.

Deep Discount

Any bottom-fishers will be looking at the aftermath of the selloff and its impact on China’s equity valuations. But while the discount Chinese shares traded at to its global peers deepened this week, it remains well above levels seen last year.

China “may have calmed some investors for now but the reputational damage is done,” said Eddie Chia, portfolio manager at China Life Franklin. “The message seems the same to me: China can clamp down any sector it deems a threat or hinders the goals of social welfare.”

Yuan Swings

As risk-off sentiment spilled over into currency markets, China’s offshore yuan swung to extremes. On Tuesday, it fell by the most in nine months, only to recoup the losses almost exactly the next day. One-week implied volatility climbed to the highest since March while traders rushed to bet on more weakness, driving the dollar’s one-year forward premiums over the currency to the highest since 2017.

”The impact on the yuan could be greater on fears that U.S. investors may be forced to liquidate their RMB-assets,” said Fiona Lim, senior FX analyst at Malayan Banking Berhad in Singapore. “Yuan weakness could be somewhat similar to what we have seen during the trade-war era.”

Bonds Outperform

While China’s most actively traded 10-year government bond saw its biggest rout in a year on Tuesday, the losses in fixed income were relatively mild compared with equity peers. The benchmark yield is still hovering close to the lowest level since July 2020. Chinese treasuries have returned about 4% this year, compared with a 7% decline in the CSI 300.

“The rout in Chinese equities, along with some accompanying yuan depreciation, does not materially change our medium-term Chinese government bond outlook,” said DBS Group strategists Duncan Tan and Philip Wee. “Most of the bond inflows in recent quarters have been structural allocations or on the back of index inclusions, and thus should be stickier compared to fast money inflows.”

Credit Check

A selloff in Chinese dollar bonds from junk-rated debt to investment-grade may be easing a little Thursday but analysts expect a toughened policy stance to continue pressuring corporate debt. With Beijing increasingly targeting the private sector -- from technology to education and property -- some investors may once again seek safety in state-owned enterprises.

The risk of a debt crisis at Evergrande, Asia’s biggest issuer of junk, is still weighing on sentiment in the riskier corner of the market. Yields on Chinese junk dollar bonds reached a 15-month high of 12% Thursday, according to a Bloomberg Barclays index.

“Asian and global credit spreads have probably bottomed, despite some relief compression today,” said Chang Wei Liang, a macro strategist at DBS Bank Ltd. in Singapore. “Asian dollar credit spreads are likely to move higher given the dual risks of an upcoming Fed taper, and an increasingly stern regulatory stance in China.”

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