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There will be no easy way out. As a leading China investment banker who had helped listing some of the biggest Chinese internet platform companies lamented during our chat, “the Chinese internet space had become uninvestable, everyone wants out”. Another fund manager who managed one of the largest China equity funds also jibed, “confidence is all but lost”.
Confidence is hard to come by and difficult to quantify, but we will give it a try any way. We look at the change in forward points in the Hong Kong Dollar (HKD,
Figure 1
). Surprisingly, despite rife pessimism, the change in forward points in the HKD is more consistent with times with higher confidence about Hong Kong’s future, such as 2007 and 2017, not with the periods of 2005, early 2016 and early 2020 when confidence was low. Historically, the forwards points paid on the HKD are closely correlated with the return of the Hang Seng. Yet, right now, the Hang Seng has absolutely tanked, but confidence in Hong Kong’s future has not waned.
Figure 1: Confidence in HK as suggested by HKD forward points has not waned, but diverged from the Hang Seng
Source: Bloomberg, BOCOM Int’l
Who is buying? Foreigners reducing
Chinese Treasury.
So who is still buying in depressing times like these? We look at cross-asset and cross-ownership holdings to gauge the penchant to buy or sell Chinese assets. Firstly, we examine the change in foreign holdings of the Chinese treasury. Our data show that foreign investors have been slowing their purchase of the Chinese treasury since early 2021, and this February they turned into outright outflow. Indeed, the outflow of US$35bn in February from the Chinese treasury is the largest single-month outflow we have since data history.
It could be due to the Russian central bank selling some of its Chinese treasury holding to raise cash, as its foreign reserve is frozen by the US. But there must be some repatriation flows as well, as some leading international investment banks have cut their ratings of Chinese treasury and advised clients to reduce holdings.
Importantly, bond investors are smart money. Historically, our data analysis shows that the change in foreign holding of Chinese treasury led foreign buying of onshore stocks and their return by up to about nine months (
Figure 2
). As such, when foreigners are reducing their Chinese treasury holdings, investors in onshore stocks must take note, as volatility will spill over from treasury to stocks.
Further, we must be mindful of the consequent pressure on the RMB, as foreigners exit. The potential contagion effect could weaken the RMB suddenly, and induce capital flight. Right now, we are still seeing orderly depreciation of the RMB. The scenario of capital flight is a risk scenario in a market where cross-border capital flows are still monitored.
Figure 2: Foreign buying of Chinese treasury bonds slowing, portending slowing offshore buying and dwindling return of A shares
Source: Bloomberg, BOCOM Int’l
Who is buying? Selling in on/offshore
stock markets.
Taking the lead from the foreign investors in Chinese treasury bonds, both on- and off-shore stock markets saw intense selling.
In Hong Kong, we are seeing the net buying activities in the market plunge to its lowest in history, and stuck there for months now (
Figure 3
). Meanwhile, our bottom-up aggregation suggests that, on the stock level, both institutional and individual investors have been dumping Hong Kong stocks (
Figure 4
). Even though the net-buying activities have been at the record low for months now, this tends to lead the eventual bottom in the Hang Seng by three months or more.
Figure 3: Buying in Hong Kong and daily sentiment plunged to one of its worst in more than a decade
Source: Bloomberg, BOCOM Int’l
And the indiscriminate selling by both institutions and individuals suggests that prevalent pessimism in Hong Kong. Such pessimism tends to ferment at some of the most difficult periods for Hong Kong, such as 2012, second half of 2015 to early 2016, as well as early 2020 (
Figure 4
). As such, even though the bottom has fallen out of the Hang Seng, it would still be rash to catch the falling knives in the near term. But we are sure long-term investors must have begun to appreciate the long-term value in Hong Kong, as suggested by the HKD forward points.
Figure 4: Both institutional and private investors are dumping Hong Kong stocks
Source: FactSet, BOCOM Int’l
The onshore market is a similar story. Net buying activity has precipitated into one of its lowest on record (
Figure 5
). However, we caution against using this measure as a market timing indicator for bottom fishing. Historically, it coincided with some of the lowest points in the SHCOMP, but not all. And its recent track record since 2016 has been blemished.
