Foreign investors have dumped a record $6 billion worth of Chinese stocks in the first three months of 2022 amid fears of new coronavirus outbreaks and the risk that Western countries will penalize Beijing if it supports Russia’s war in Ukraine.

Chinese stocks took a heavy blow early this week as Covid-19 cases rose in major cities like Shanghai and Shenzhen, continuing the declines that have shown sustained in the year so far.

Local investment has picked up again after Beijing announced it would take a series of market-friendly measures. But foreign stocks listed in mainland China don’t.

That divergence, investors and fund managers say, reflects a host of concerns that have dented valuations, even from companies that led China’s 2020 stock rally, as the market posted global gains as a result of Beijing’s early success with its strict “zero-covid ” policy.

“Over the past two weeks, Chinese stocks have been thrown into a perfect storm,” said Pruksa Iamthongthong, senior investment director for Asian equities at fund management giant Abrdn. She added that global investors’ confidence in Chinese equities is “so low that some of this volatility will continue”.

Pat Lu, a Hong Kong-based portfolio manager for Neuberger Berman who specializes in emerging markets, added that “when we generally fear the markets, we are skewed to seek risk and that’s what happens”.

Chinese stocks have lagged throughout the year. The benchmark CSI 300 index is only 4 percent higher than at the end of 2019, when the first Covid-19 outbreaks were reported in China. The Nasdaq Golden Dragons index of major Chinese technology groups listed in New York is down about a quarter.

In comparison, the US S&P 500 and tech-focused Nasdaq Composite are up about 37 percent and 52 percent, respectively, over the same period.

Foreign outflows through Hong Kong’s so-called stock connect trading programs with Shanghai and Shenzhen began on March 7, but increased dramatically earlier this week.

By the end of Friday, net sales by offshore investors this year were close to Rmbn 40 billion ($6 billion), on track to mark the worst quarter since that peg settlement began in 2014. The sell-off marks a sharp contrast to 2021, when net inflows through the scheme topped Rmb430bn.

Column chart of net flows to Chinese markets via Hong Kong's stock connect scheme (Rmb, bn) showing foreign investors dumping Chinese stocks at record pace

Investors pointed to three key drivers of foreign sales: renewed concerns about possible cuts from Chinese stock trading in New York, the rise in Covid-19 cases in major mainland cities, including Shanghai and Shenzhen, and concerns about the possibility of China becoming Russia. supports the invasion of Ukraine.

On Tuesday, after Chinese stocks booked their second day of double-digit declines, JPMorgan lowered 28 of the 29 Chinese internet stocks it covers to underweight or neutral. “We recommend investors avoid the internet in China on a six to 12 month basis,” the analysts wrote, describing the sector as “unappealing, with no near-term valuation support.”

An executive at the Hong Kong arm of a global hedge fund said the start of the week “felt like 2015” as the leveraged stock bubble exploded seven years ago.

But on Tuesday, Liu He, a deputy prime minister and close economic adviser to President Xi Jinping, announced that the government would take measures to “stimulate the economy in the first quarter” and introduce “market-friendly policies”.

State media immediately backed He’s post with reports on talking points from a special meeting of China’s financial stability commission he had just chaired, including a call for “quickly full rectification of China’s major technology platforms” and a move to scrap regional test runs for real estate taxes that had weighed heavily. on project developers.

“The message is very clear: the Chinese government wants to send out a strong signal of market support,” said Jessica Tea, investment specialist for Greater China and Asia-Pacific equities at BNP Paribas Asset Management. “It appears they are halting regulatory tightening to provide more support and bolster market confidence.”

The string of market-friendly promises from Beijing was quickly followed by some global investment banks switching to upgrade Chinese equities.

Credit Suisse announced Thursday it would increase its allocation to Chinese equities to overweight, as Michael Strobaek, the bank’s global chief investment officer, labeled Beijing’s move “significant”.

Line chart of stock indices (again based on 100) showing Chinese stocks moving from pandemic leaders to laggards

Strategists at Citigroup also upgraded Chinese equities to overweight on Thursday, saying that if authorities deliver on their promises, “it would remove almost any overhangs over Chinese equities that the market had been concerned about.”

But both banks formulated their intentions to buy more stocks as “tactical” — usually an indication that buying will be limited or targeted at specific stocks, rather than increasing exposure to the Chinese market as a whole.

Analysts also warned that after so much pain for Chinese stocks in the past 12 months, it would take time and concrete action to regain the confidence of global investors who had been repeatedly burned.

Thomas Gatley, an analyst with Beijing-based consulting firm Gavekal Dragonomics, said the commission’s statement was “in terms so positive that if they don’t deliver within the next month . . . we will see another drop of see the markets”.

Gatley added that, like many pledges from top officials, the statement was carefully worded to provide plausible deniability if Beijing’s priorities suddenly shifted or regulators went ahead with disruptive enforcement measures already in the works.

“Which [approach] works quite well for macroeconomic policy in general and the governance of a large, diverse country,” he said. “But it’s not that great for market signalling.”

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