China Markets Brace for Wild Swings in Year of the Monkey

After recent global market turmoil, analysts say Chinese stocks unlikely to emerge unscathed from Lunar New Year holiday

By Chao Deng

 A man does tai chi in Shanghai, China, on Tuesday, Feb. 9, 2016, during the Lunar New Year holiday. Analysts are expecting mainland markets, which were closed last week, to face turmoil Monday.

A man does tai chi in Shanghai, China, on Tuesday, Feb. 9, 2016, during the Lunar New Year holiday. Analysts are expecting mainland markets, which were closed last week, to face turmoil Monday. Photo: Bloomberg News
HONG KONG—Investors in Chinese stocks are facing a tumultuous return to action Monday after a weeklong holiday in mainland markets for the Lunar New Year shielded them from the global market turmoil.

Chinese shares are already among the world’s worst-performing this year, with the main benchmark Shanghai Composite Index down 21.9% at 2763.49. The market has almost halved in value since its peak last June, dropping some 47% since then.

But analysts say both the Shanghai and Shenzhen stock exchanges could face further sharp losses at Monday’s open, as they catch up with the past week’s mostly gloomy global markets.

Japanese stocks sank 11% last week and the yen shot up, defying a recent move by the Bank of Japan 8301 -5.76 % to introduce negative interest rates, partly designed to keep the local currency weaker and help Japanese exporters. Markets in Europe and the U.S. whipsawed as investors lost faith in banking stocks, while Australian shares entered bear market territory, having fallen more than 20% since their most recent peak in late April.

Meanwhile, Chinese stocks trading in Hong Kong lost 6.8% and the city’s benchmark Hang Seng Index fell 5% in the two days markets were open here at the end of last week.

“There will be an incredible amount of strong psychological pessimism in China this week,” said Richard Kang, co-founder and former chief investment officer of New York-based Emerging Global Advisors LLC. “[Global assets] are going up and down together, it’s very macro-driven right now.”

China was at the epicenter of market mayhem at the start of 2016, as shares fell sharply and the country’s currency, the yuan, dipped in value.

Before last summer, Chinese market slumps had little impact beyond the country’s borders, mainly because stock-buying there remains largely driven by local retail investors. Foreign investors still account for a small amount of stock ownership in China.

But the Chinese selloff early this year was met with a confused response from Beijing policy makers, who flip-flopped on new measures to stem the market bleeding and were criticized for failing to communicate clearly a change in currency strategy. That contributed to a perception among global investors that Chinese leaders have lost their grip on the country’s economy.

The nervousness in markets around the world has now taken on new dimensions. Central banks are struggling to boost growth, despite the Bank of Japan joining the European Central Bank in setting negative interest rates for the first time. Bank profits face a squeeze as the margin between what they pay out on deposits and what they make on lending narrows. Low oil prices are also continuing to weigh on energy stocks.

Chinese markets seem unlikely to escape the prevailing gloom, analysts say. “We’re in a time now where global investors are hypersensitive to any reasons to sell,” said Louis Lu, fund manager at CSOP Asset Management in New York.

China’s mainland market was relatively stable before the holiday break, as the central bank worked harder than usual to maintain liquidity. The Shanghai benchmark rose 1% in the week ending Feb. 5.

Already cheap valuations for stocks there could limit further downside, say some analysts.

Blue-chips trading on the mainland are already among the cheapest in the world based on their price relative to their expected future earnings, even less expensive than blue-chips trading in Russia, where the economy is in recession.        

A rising Japanese yen could also give China’s central bank more impetus to guide the yuan stronger, a potential balm for equity investors. The yuan strengthened about 1% against the U.S. dollar last week in the freely-traded offshore market, although the domestic market for the currency was closed. Beijing signaled last year that the yuan should move in line with a basket of currencies, not just the greenback.

Still, there is an Achilles’ heel for investors in China: Analysts say capital outflows are increasing, and a slowing domestic economy could warrant another sharp devaluation in the Chinese yuan before year-end.

Over the holiday break, China said its foreign-currency reserves plunged for the third consecutive month in January to $3.23 trillion.

Fresh economic releases this week, including Chinese trade, inflation and new loans data, are expected to deepen concerns that Chinese growth is deteriorating. Exports likely dropped 2.4% year-over-year in January in dollar terms—steeper than a 1.4% decline in December—according to economists’ forecasts of data due Monday. The trade surplus may have widened slightly, but analysts say that is unlikely to have offset capital outflows.

Investors say Chinese authorities will likely hold back on fresh monetary easing, which would speed up capital outflows now, although government funds could buy up select shares to support the market directly, as they have done in the past.

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