LONDON (Reuters) - China’s $2 trillion equity rout may not be over yet but some foreign investors, far from fleeing a volatile market dominated by small-time traders, are swimming against the tide and buying more shares.
Some in this small band of optimists see historical parallels with Japan, where the stock market matured long after its export boom peaked. Others believe private Chinese investors will eventually return, seeking returns on their huge savings.
The six-week selloff in the world’s second-biggest equity market - A-shares listed in Shanghai and Shenzhen - has wiped a third off the market’s value and ruined local punters who had borrowed to invest just as the index peaked.
While foreigners own only around 2 percent of these markets, they too suffered as selling engulfed the Hong Kong- and New York-listed shares of Chinese companies.
The volatility has possibly turned many investors off A-shares for good. More than $14 billion has flooded out of funds dedicated to China this year, with big losses in the two latest weeks.
But a minority sees the losses as a short-term wobble in a market which is still maturing and will eventually join world equity indexes.
“We have used the volatility to go overweight a number of sectors such as tourism and insurance. I think the A-share market will consolidate and find a reason to go higher,” said Yu-Min Wang, chief investment officer at Nikko Asset Management which runs around $170 billion.
Wang bases his optimism on the experience of Japan which became an export powerhouse in the 1960s and 1970s, years before the Nikkei index took off and drew in international investors. China produces a fifth of the world’s economic output, he said, but its shares are just 2.4 percent of MSCI’s all-country index.
“At some point, the magnitude of the Chinese market has to reflect its industrial might. I postulate that China is where Japan was in the ‘60s and ‘70s, in the period just before industrialisation slows and that’s when the equity market goes up in a significant manner,” Wang added.
As with all investing, the right timing is essential. The Nikkei soared through the 1980s, only to crash after peaking at almost 40,000 points at the end of 1989. A quarter century later, it is little more than half that level.
Such arguments are based anyway on a long-term view. Those with a more immediate approach may find comfort in Chinese regulators’ measures aimed at preventing a wider crisis.
Steps such as restrictions on new share listings - blamed for years of equity underperformance - and interest rate cuts - will now support prices, some argue.
Undoubtedly the selloff was panicky and indiscriminate, driven by the small investors who account for 85 percent of daily A-share trade. After the shakeout, many of them will venture back, Citi predicts, pointing to bank deposits of $20 trillion, double China’s annual economic output, which are growing at 14 percent a year.
With deposit interest rates expected to fall and the authorities still keen to boost equity investment, some of this cash will find its way to the stock markets, Citi added.
Jennifer Wu, client portfolio manager at JPMorgan Asset Management, may also consider buying. “(The selloff)...does not reflect actual deterioration in the market or economy. We are likely to be buyers or adding to stocks that have become more attractively valued,” she said.
Wang and Wu are in a minority but many foreign investors share the view of Goldman Sachs that Chinese shares are undergoing “a correction not a collapse”.
Goldman said A-shares in some big firms which plan to buy back their own stock look attractive after the fall, along with those where local investors have liquidated leveraged positions.
More volatility is likely, Goldman warns, but it also sees Shenzhen equities rising 20 percent in the coming year.
A-share investments have over the past year rewarded overseas funds, as they tended to cluster around blue chips which were less caught up in the market’s boom-bust.
Kathryn Langridge, head of emerging equities at Manulife Asset Management, names Daqin Railway and SAIC Motor as examples of stocks less likely to be affected by emotional rather than rational behaviour among local investors.
“You do run the risk of underperforming for a while but there are strong reasons to own those stocks. A lot of the animal spirits have been in companies we regard as un-investable,” Langridge said, adding that she might buy more as shares get cheaper.
One draw is the possibility that A-shares will eventually be included in indexes run by providers such as MSCI. These currently admit only offshore-listed Chinese firms and MSCI decided recently against changing this, citing barriers to non-residents’ participation in the mainland markets.
Inclusion someday is considered inevitable and because these indexes are the yardstick for funds running trillions of dollars, admission can bring huge inflows. For adventurous investors, it makes sense to get in on the ground floor.
“If it does get included, people will get more comfortable getting in. “One day (mainland China) will be a very big part of portfolios,” JPMorgan’s Wu predicted.
Graphic by Vincent Flasseur; editing by David Stamp