Shanghai Stocks Falling Out Of Favor As Central Bank Tightening Hard On Track

The Shanghai Composite Index had its worst day of the year Thursday, down 2.3%. After beginning a well-defined price uptrend that started in May 2017, Wednesday’s move could trigger sensitive momentum algorithms to exit long positions, particularly those formulas that focus on price channel patterns and downside deviation consistency models.  But beyond the algorithmic factors, there are fundamental concerns, notes a Deutsche Bank report. Some of these issues are long-term and involve slower moving central planning models while others are shorter term in basis.

Regulation is a short-term concern of Chinese investors

Hong Kong stocks have been moving meaningful higher recently. The Hang Seng Index closed up 2.3% on the week, its fourth week of advances, pushing the index above the 30,000 mark for the first time in 10 years. Up nearly 35% on the year, Hong Kong stocks have benefited from investments emanating from mainland China, according to Goldman Sachs Chief China Equity Strategist Kinger Lau, who is forecasting 32,000 by year-end.

The Shanghai Composite, however, hasn’t been so lucky, indicating a degree of idiosyncratic factors rather than larger regional issues taking stocks lower.

Perhaps the most immediate factor driving the Shanghai stock market lower Thursday was a regulatory concern.Deutsche Bank Chief Chinese Economist Zhiwei Zhang credits the move lower to concern for tightening regulation in the asset management sector.

“Tight liquidity and escalating regulatory oversight are the excuse to sell,” Wang Zheng, chief investment officer at Jingxi Investment Management in Shanghai, was quoted as saying. “The most important thing is that those institutional investors want to be the earliest to cash out of these stocks with outsize gains to be ranked among the top as the year-end is coming nearer.”

But Deutsche Bank notes a more pervasive force impacting markets, one whose influence is not immediately seen.

Chinese policymakers are not letting up on their tightening regime despite slowing property sales

Central bank policy tightening typically is not seen in markets for three months, Deutsche Bank's Zhang noted in a November 23 report. A previous tightening, then, is likely influencing property prices in China.

“Upon introduction of tightening policy, the price momentum tend to last for another 2-3 months, driving property prices even higher than in the control group,” he wrote. “After that, the pace of price increases becomes slower than in the control group, and stays slower for the next 5-6 months.”

Looking at Tier 3 cities, the hottest of the property markets in 2017 with sales up 32% year over year, there is a noticeable slowing in the sales momentum. Zhang notes that property prices have begun to stabilize in Tier 3 cities, with Tier 1 and 2 cities have already witnessed a decided slowing trend.

“Prices in non satellite tier 3 cities are still rising, at a much slower pace,” Zhang noted, pointing to just 0.4% growth in the second half of 2017 versus 2.5% growth in the first half.

The slowing real estate market could be impacting asset prices overall. But will the slow ratcheting up of central bank pressure continue? Zhang thinks so.

The Ministry of Housing (MoH) along with the People’s Bank of China (PBOC) called a meeting with some local governments on Nov 21 to discuss housing market policy, which the markets were closely watching. The meeting “sent a strong message” but also highlighted a dichotomy. As property sales turned negative in October for the first time, the meeting’s message was strident: There will be “no change in policy goal" and "no relaxation” in the strength in which this goal is exercised.

The official levers of housing policy in the country have spoken, and they are more concerned about risk management than boosting growth. When a strong appetite for growth is absent, so too is generally an appetite for regional investments.