July 27, 2018 / 4:42 AM / in 9 months

GRAPHIC-More pain in store for China stocks as inflows, earnings slacken

July 27 (Reuters) - China’s stock markets are already the world’s worst performing major equity market this year and risks are skewed for further losses if an easing of foreign portfolio inflows and analyst revisions to earnings estimates are anything to go by.

While market participants mostly agree the stock markets are pricing in sharp downgrades in earnings, most think concerns of a market rout and an economic hard landing are overdone.

The Shanghai Composite index is down about 13 percent this year, while the blue-chip index has fallen 12 percent.

Latest data from Hong Kong stock exchange shows northbound flows from Hong Kong into mainland China through China’s Connect channels for foreign investment were 15.1 billion yuan in the first three weeks of July, hinting July would see a second successive monthly fall in net flows. Investors have been expecting heavier inflows after China’s A-shares were included in the U.S. index publisher MSCI’s emerging-markets benchmark this year.

The slowing inflows suggest investors are reluctant to bet on Chinese stocks despite the government’s efforts to prop up the markets with its fiscal and monetary easing measures as growth slows and the country braces for the impact of the bitter tariff dispute with the United States.

Analysts have over the past month cut their outlook on Chinese companies’ earnings in the next four quarters as the nation faces a slowdown in economic growth and likely disruption in exports.

The world’s two largest economies have already imposed tariffs on $34 billion worth of each other’s imports. In his latest threat to China, U.S. President Donald Trump has said he was ready to impose tariffs on all $500 billion worth of Chinese imports.

Industrials and material sectors derive a major chunk of their revenue from exports and will face the brunt of the trade tariffs imposed by the United States.

The two sectors have fallen sharply since March, when Trump raised tariffs on steel and aluminum imports, and their profit estimates have also been cut.

The economic headwinds has seen the yuan fall to its lowest in more than a year as the U.S. dollar rose broadly and Beijing’s easier policy bias caused yield differentials between China and the United States to narrow further.

While the U.S. central bank is set to further raise its interest rates before year-end, China has cut its bank reserve ratio twice this year, injected money through open market operations and said it will use fiscal policy proactively.

Analysts said this policy divergence between the two countries will push down the yuan further.

A weaker yuan helps the country’s exports revenue, but also increases the interest burden of firms that have dollar-denominated debt.

“A further slide in the yuan is likely to spook the market, as it will make it more difficult for borrowers to service their dollar debt,” Kevin Lai, chief economist for Asia ex-Japan at Daiwa Capital Markets said in a report.

Historically, the correlation between Chinese stocks and the yuan rises when the latter declines.

Though China’s major stock index has rebounded sharply this month, it is still the worst performing among the top indexes in the world in 2018.

Reporting By Patturaja Murugaboopathy Editing by Vidya Ranganathan & Shri Navaratnam

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