Deepening Selloff in Chinese Stocks Raises Concerns

A further decline in Chinese stocks has heightened concerns, with a key index reaching a five-year low and erasing gains made the previous week amid optimism about stronger support measures from authorities. The CSI 300 Index of mainland shares dropped 0.9%, falling below its January 22 close despite promises of more robust support from authorities. Expectations of a 2 trillion yuan ($278 billion) rescue package and a central bank decision to cut banks’ reserve requirement ratio had initially sparked optimism.

The benchmark gauge witnessed a significant 6.3% slump in January, marking a record sixth consecutive month of losses. Worries persist that the authorities’ efforts may not be sufficient to counter the economic downturn and the ongoing property crisis. The recent decision by a Hong Kong court to liquidate China Evergrande Group and concerns over losses related to snowball derivatives and structured derivatives in Hong Kong have added to the market’s woes.

Investor sentiment remains bearish, and any minor rally triggered by incremental government support news is met with more selling, according to Vey-Sern Ling, Managing Director at Union Bancaire Privee in Singapore. Questions arise about whether China can address its structural issues and the leadership’s commitment to prioritising growth.

The economic outlook for China seems to be deteriorating, as recent data reveals a contraction in factory activity for the fourth consecutive month in January. Over $6 trillion has been wiped off the market value of Chinese and Hong Kong stocks since the peak in 2021, prompting calls for bolder measures from authorities to reverse the downward trend.

While news of a potential rescue package provided a brief boost last week, concerns persist about the market’s ability to sustain positive momentum. Signs of state-led funds making purchases to support share prices have emerged, with some Chinese exchange-traded funds experiencing record inflows this month. However, the fact that share prices have reversed gains from the previous week underscores the pervasive pessimism among investors.

The current downturn is partly attributed to the impact of a relatively new financial derivative known as a snowball. These derivatives, tied to indexes, trigger selling of related futures positions when gauges fall below predefined levels. Additionally, retail traders in Hong Kong faced banks calling in $1.55 billion of leveraged derivatives during the recent stock slump, exacerbating volatility and highlighting risks associated with structured products. Despite recent support measures, market pessimism remains, and the outlook for Chinese assets is viewed cautiously by experts.