In recent days, China has been hit with a tripple whammy of rising inflation, reducing the likelihood of more monetary easing; a jump in the dollar which has pressured the Yuan sending it to its lowest fixing since 2010 at 6.7379, while the USDCNH rising above 6.75 in early trading; and rising interest rates which have resulted in another spike in revulsion to EM stocks. Perhaps as a result of this perfect storm of catalysts, overnight China’s foreign currency shares, the Shanghi B-share index, plunged the most since January in late trading, and as Bloomberg notes, “sending traders scrambling for reasons to explain the sudden volatility in a largely moribund market.”
The Shanghai B-share index of dollar-denominated stocks suddenly crashed as much as 6.7%, the biggest drop since January 11, with virtually all the losses coming in the last 90 minutes of trading, before closing down 6.2%.
Kama Co. and Shanghai Lingyun Industries Development Co. were among companies falling by the 10% limit. Predictably, a measure of the 10-day volatility on the 52-member index jumped to its highest level in six months, after falling in September to its lowest in at least a decade.
As Bloomberg summarizes, B-share markets, where foreign institutions and Chinese individuals are allowed to trade, were set up in 1992 to give local companies a way to raise funds from global investors banned from buying securities denominated in yuan. Interest in B shares has waned as the government allowed qualified overseas investors to access the larger, more liquid A-share market and eased limits on foreign exchange. Monday’s drop came as the yuan extended a slide against the dollar to a six-year low.
“There’s no clear explanation on the sudden drop,” said Castor Pang, head of research at Core-Pacific Yamaichi Hong Kong. “But most investors are deeply concerned about the yuan’s depreciation and capital outflows as the yuan approaches 6.8. Overall market sentiment is very poor and selling in the B-shares index is spreading.” But we thought China was fixed, or at least that’s what the “objective” media said?
Turns out the media was wrong as usual: Northeast Securities strategist Shen Zhengyang also blamed the Yuan exchange rate is one major factor for movement in B shares, adding that investors are worried yuan might depreciate further against the USD after recent weakness. It appears China’s capital outflows are also nowhere near done, refuting yet another optimistic media fable.
Investors are “probably selling dollar-denominated B shares and want to get the money out if they still have forex quota” he added.
Then there is the fact that the plunge was long overdue: the Shanghai-B market is a bubble, which trades 30x reported earnings, almost double the 18 multiple for the Shanghai Composite Index. The Shanghai Composite, comprising both yuan-denominated A and foreign-currency B shares, slid 0.7 percent, erasing an earlier 0.2 percent advance. The selloff comes amid a period of stability for Chinese equities after last year’s $5 trillion rout, with turnover on the Shanghai exchange near two-year lows and the benchmark gauge treading water. That said, the only reason for the stability is that as retail investors have fled the local stock market, the government has effectively taken over and no longer allows material swings in underlying risk.
But ultimately, today’s crash is likely a confirmation that Chinese capital outflows continue.
Mainland investors have been looking at ways to protect against a weakening yuan, with net buying of Hong Kong stocks via a Shanghai link swelling to a record last month. The Chinese currency slid 0.2 percent to 6.74 per dollar at 3:49 p.m., after sinking 0.8 percent last week.
“There is market speculation that B shares can no longer be used as a tool to hedge against the yuan,” said Jackson Wong, associate director at Huarong International Securities Ltd. in Hong Kong. The State Administration of Taxation last week published rules requiring banks to perform due diligence on non-resident financial accounts from 2017.
“We saw some unknown institutions’ heavy selling around 2 p.m.,” said William Wong, Hong Kong-based head of sales trading at Shenwan Hongyuan Securities Ltd. “It is very likely that some overseas investors want to move money out” after the new rules.
One thing is certain: if this capital outflow pathway is closing, Chinese intrepid residents will just find another way to transfer more of theit $25 trillion in domestic savings abroad.