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Debating the traps of a Chinese bear market

With Chinese stocks having officially entered bear territory earlier this week, industry experts are divided on which neck of the woods the market will end up in.

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The Shanghai Composite Index closed on 29 June down 3.3%, meaning that Chinese stocks had dropped 20% in two weeks having risen more than 100% in 12 months.

The following day, markets offered a glimpse of hope as they clawed back more than 5%, only to drop 5.2% on 1 July.

A key driver of these massive fluctuations was the Chinese A-shares market, that have recently experienced an influx of new money, mainly from Chinese retail investors, but also through the opening of the Stock Connect programme, that has begun to open up access to foreign investors.

It is these characteristics, explained Paul Niven, manager of the F&C Investment Trust, that underline why he is currently reluctant to hold a significant Chinese weighting.

“China is an area that we are underweight, which comes back to a quality problem,” he said.

“We do not equate quality with the A-share market, which is trading $250bn a day compared to the DAX trading $6bn a day. Open interest is very low and holding periods are very short, implying that there is a tremendous churn.”

Justin Oliver, deputy investment officer at Canaccord Genuity Wealth Management, believes that Chinese stocks having climbed so far in the past year meant that a backslide was inevitable, and could have implications beyond China’s borders.

“There has been such a massive run-up in Chinese shares that anyone who thought it could continue or even flat-line was barking up the wrong tree,” he said. “The correction was always going to happen, it was just a case of when and from what level.

“This could have an impact in other Asian stock markets, if people see what is happening in China and decide to pare back. Chinese A-shares are not that easy to access, and if you hold them as an institution you probably want to keep them, therefore the way to scale back risk is to pull back your positions and buy them back at a later date.”

However, while he is put off by valuations in the short-term, Niven does have a view to increasing his existing Chinese holdings over the next year based on what he sees as a potential upturn in growth during the latter half of 2015.

“I do expect to add more to emerging markets, but not yet,” he explained. “They are cheap, but they are cheap for a reason, and a strong dollar, rising rates and falling commodities prices are all negatives.

“Chinese growth will be picking in the second half of the year. Nominal growth in China has fallen from 20% several years ago to 7-8% now, and government policies that we are seeing now and some of the wealth effect that is spilling over from asset price inflation is going to lead to a pick-up, though it will be much lower than we have seen historically.”

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