Chinese stocks often operate in their own little world. But right now, they are making waves well outside China's shores.
The CSI 300 index, made up of the 300 largest Chinese companies listed in Shanghai and Shenzhen, has slumped 4.1% since Nov. 22, in just four trading days, after climbing to its highest level in more than two years.
Chinese stocks are highly sentiment driven, with flighty retail investors dominating trade. They tend to look for momentum, and they invest according to short-term whims rather than any fundamental justification.
That's part and parcel of the Chinese economy as a whole, where policy changes overnight, with no warning and even less recourse.
The CSI 300 is still up 22.4% so far this year. It's been on a pretty steady rise since late January 2016, the end of a 45% freefall since the middle of 2015. That half-year collapse was prompted by concern that the Chinese government was turning off the spigots on credit so tightly, that the economy was grinding to a halt.
Are we witnessing the start of another sustained downturn? Those kind of drops -- and subsequent reversals -- are not unusual in the Chinese markets. It's par for the course for the entire stock market to double, halve, then double again -- as it did in 2007 (up 190%), 2008 (down 70%) and 2009 (up 107%).
The pessimism in 2015 parted heading to the end of the year, and China averted any nasty "hard landing." Evading predictions of a grinding halt, 2016 growth, at 6.7%, was only narrowly down on 2015's 6.9%. It's clear that the economy is still growing at a very nice pace, thank you, and actually gained a tiny bit of pace this year.
Once again, it has been fears over the access to credit that have been hitting Chinese stocks over the last few trading days. Blue-chip companies have sold off after the government floated new measures to police the asset-management industry. That's part of a long-running effort to curb wayward and risky lending.
By some counts, China's total debt is as much as three times the size of its economy. State-owned enterprises spend around 25% of their entire revenues just on servicing their debt, according to calculations by Reuters.
China Inc.'s debt pile is getting bigger, rather than declining, with China-listed companies having seen their debt jump 23% as of the end of September, compared with a year ago. That's the highest rate of growth since 2013, according to a Reuters analysis of the financial data of 2,146 publicly traded companies in China, around three-fifths of the total.
Real estate was one of the prime culprits, with the sector's debt having multiplied over the last five years. Industrial companies come next.
It's the flow of speculative money raised through the "shadow banking" system of high-yielding, but murky wealth-management products into what often ends up being the property and stock markets that the government is trying to combat. Beijing on Nov. 17 introduced stricter guidelines on the regulation of the asset-management businesses that generate some of those speculative products, which often invest into blind pools of assets that investors know nothing about.
Those new rules, which in any case are only now in draft form, will not come into effect until the end of June 2019. But investors have, since their introduction, taken them as a sign that the momentum is moving against markets as the government continues its crackdown on over-borrowing and suspect credit.
Now, investors should watch for whether there's any resurfacing of the negative sentiment that enveloped Chinese markets in 2015. If the asset management rules make the wealth-management products of banks less attractive, that will ultimately result in a loss of liquidity in the Chinese stock markets.
Real estate is a particular concern. Once again, as it did in 2015, China's housing investment is slowing fast. It has declined from more than 10% at the start of this year to virtual stagnancy now. That then feeds through to a lack of construction demand.
Chinese President Xi Jinping got his loudest and longest ovation for his assertion that "houses are built to be inhabited, not for speculation," during his three-and-a-half--hour agenda-setting speech to the to the Communist Party congress in October. The unified applause suggests that there's a consensus within the party that China's property prices had got out of control -- and must be brought to heel.
Investors should choose their China exposure carefully. The MSCI China is up a whopping 53% in 2017, double the gains in the CSI 300. This is explained by its hefty weighting to Chinese tech stocks listed outside China, with Tencent Holdings (TCEHY) and Alibaba Group Holding (BABA) both having doubled this year. The MSCI China index has 41% of its makeup given over to tech.
Long-term, these stocks likely warrant the attention they are getting, since they are both growing fast and extremely profitable, as I explained yesterday. But that extreme over-weighting is making many market watchers nervous.
The iShares MSCI China ETF (MCHI) is the easiest way for U.S. investors to map the performance of that tech-heavy index. The Deutsche X-trackers Harvest CSI 300 China A-Shares Fund (ASHR) and the VanEck Vectors ChinaAMC CSI 300 ETF (PEK) follow the mainland-only index.
Nomura (NMR) is trimming its tech exposure, and Société Générale now favors a rotation to old-economy sectors. It also believes the Hang Seng China Equities index will outperform the MSCI China index. That's partly as mainland investors move money south via the Shanghai and Shenzhen stock connect schemes from expensive A shares traded in mainland China to cheaper Hong Kong listings.
One of SocGen's strategies to capitalize on the restriction of credit that China is going through, and play into its debt themes. To that end, investors can focus on companies that are deleveraging. These are companies that currently have a high debt burden, but are doing a good job of reducing it.
The bank has created a basket of nine stocks that are following this process, all of them with their primary listings in Hong Kong, a market U.S. investors can easily access, with options, futures and shorting normally possible. What's more, they nearly all have U.S. tickers via secondary listings or ADRs, too.
They are: the world's largest paperboard maker Nine Dragons Paper Holdings (NDGPY) ; China's largest aluminum producer the Aluminum Corp. of China (ACH) (better known as Chalco); the operator of the Beijing Capital International Airport (BJCHY) ; the country's flagship carrier, Air China (AIRYY) ; China's largest carrier in terms of passengers, China Southern Airlines (ZNH) , the three property developers Sino-Ocean Group Holding (SIOLY) , Soho China HK:0410 and China Resources Land (CRBJY) , toll-roads builder and operator Jiangsu Express (JEXYY) , which runs five expressways; and China Railway Group (CRWOY) , which does build railways, but is also one of the biggest infrastructure contractors in the world.
That basket provides plenty of exposure to "old-economy" sectors. Many of the companies benefit from China's heavy spending on infrastructure, which has been an area where the government has been splashing rather than curtailing access to cash.
China's growth is slowing, but not stalling. Gross domestic product is expected to expand by 6.8% for 2017, according to Oxford Economics.
That means it has recaptured the title of "world's fastest-growing economy," at least among those that matter, from India. India's reforms have for a change been China-style, fast and dramatic, with 86% of cash rendered worthless last November. That and a sales tax knocked India's economic advance from 7.9% last year to an expected 6.5% in 2017, according to Oxford Economics.
China is in the first throws of a difficult transition. Services make up an increasingly large share of the economy, and two-thirds of its growth rate. As China's state-owned enterprises are forced to reform, that's likely to curb economic expansion by a full percentage point, to 5.7%, by the turn of the decade.
But China is equally a $9.5 trillion economy now, meaning it has tripled in size since just 2004. It couldn't and shouldn't sustain that pace of growth. Investors should respond with a more-mature approach to an increasingly developed economy, but one that, debt problems aside, still has a long way to go.