Political Risk Continues To Weigh On China Stocks

The rout in China equities accelerated in recent weeks amid Beijing’s increasingly aggressive regulatory crackdown on its domestic businesses. The market bounced in Thursday’s trading session (July 29) after diving earlier in the week, but on a year-to-date basis a deep shade of red ink prevails for the country’s stock market.

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Equities in China remain the downside outlier for a set of US-listed ETFs that represent the major regions of the world’s stock markets. The iShares MSCI China ETF (MCHI) has lost 10.9% so far in 2021 (through Wednesday, July 28). That contrasts with gains for shares throughout much of the rest of the world.

A global equity benchmark is up 13.6% year to date via Vanguard Total World Stock ETF (VT). US stocks are up even more this year: SPDR S&P 500 (SPY) is currently ahead by 18.1%.

The bounce in China stocks in today’s session appears linked to reports that Beijing is trying to calm fears following the government’s regulatory crackdown. Bloomberg reports that “the nation’s securities regulator convened a video conference with banking executives Wednesday night.”

It’s unclear if market sentiment will recover quickly. “International investors are bloodied by the experience and will remain suspicious that overseas quoted Chinese companies are under heavy scrutiny by policy makers,” says Gary Dugan, chief executive officer at the Global CIO Office.

For now, at least, skepticism is well-founded. As the Financial Times observes, “China’s crackdown is designed in part to demonstrate the state’s control over the economy, in contrast to US and European regulation which generally aims to protect consumers or ensure that markets function better.”

To the extent that Beijing’s crackdown reflects policy, reversing the crackdown will be politically difficult and so any publicly announced changes in the weeks and months ahead may be cosmetic.

Some analysts are taking a longer view and see the latest slide as a buying opportunity. Small-cap China stocks in particular look attractive, says veteran emerging markets investor Mark Mobius.

“What’s happening is a good thing,” he told Bloomberg earlier this week. “What the Chinese government is doing is cracking down on the big companies that dominate various sectors at the exclusion of smaller companies. So the regulatory crackdown is probably in the long run going to be good for the Chinese market.”

Perhaps that reasoning explains why iShares MSCI China Small-Cap (ECNS) has outperformed MCHI, its big-cap counterpart. In fact, ECNS latest bounce brings it back into positive year-to-date territory.

“Beijing’s clampdown is a harsh lesson for global markets,” writes Nicholas Spiro, a partner at Lauressa Advisory, a London-based real estate and macroeconomic consultancy. “Yet, there is little sign that investors have fundamentally changed their view of China. If the recent sell-off forces investors to price political risks more accurately – both in China and elsewhere – markets will be better prepared for the next bout of volatility.”

Disclosures: None.

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