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Foreign Investors Take Flight from Mainland Stocks on Last Day of Stock Connect Before Chinese New Year

Key News

Asian equities were a sea of red with virtually every market off other than India, Indonesia, and the Philippines . Taiwan was closed today for Chinese New Year, which spared it from the carnage. Hong Kong and Mainland China were hit especially hard. While the coronavirus dominates headlines, the reality is today was the last day for foreign investors to sell Mainland stocks via Northbound Stock Connect, the trading venue for accessing mainland stocks via Hong Kong as Mainland exchanges close until next Friday. Foreign investors sold $1.69 billion in elevated trading as Northbound Connect accounted for just over 5% of Mainland turnover, which is higher than 4% average. Today was eerily similar to Tuesday’s trading in Hong Kong, which was the last day for Mainland investors to sell Hong Kong stocks via Southbound Connect. Why the selling? The simple reality is that the market has done fantastic! Investors are pocketing profits in advance of the holiday as Hong Kong is closed on Monday and Tuesday and the Mainland is closed from this Friday until reopening next Friday. 

One segment of foreign investors are hedge funds that don’t want to see their money tied up in China until next Friday. Mainland investors, on the other hand, are simply taking profits to fund their holidays. Selling in Hong Kong and on the Mainland was indiscriminate as even healthcare stocks were hit, though Macau and airline stocks were hit harder. I’m a believer in active and passive as both contain pros and cons though the prevalence of active in EM is much higher than it should be in my opinion. How could active managers avoid today’s carnage with virtually every stock down in both the mainland and HK? They didn’t! Markets are apt to chop around the next few days on coronavirus headlines but the reality is that asset managers will use the dip to buy Mainland stocks. Active EM managers were underweight China in 2019 despite its strong performance. The modest outflows this week appear minor relative to the large inflows into Mainland stocks since the beginning of November, 2019.

What do we know about the coronavirus? The WSJ had a good overview written by Betsy McKay, which I recommend. For those infected, the “mortality rate from the Wuhan virus is tracking at roughly 3%.” SARS and MERS had mortality rates of 10% and 1/3 of those affected. The article states that those who died from coronavirus “were over 60 years old, had other illnesses such as diabetes, and were admitted to hospitals when their illness advanced.” I have absolutely no medical training whatsoever, but I would suspect flu/pneumonia illnesses such as the coronavirus can be much more severe for smokers, of which China has plenty. According to one of our favorite Mainland brokers, SARs ran from November 2002 to July 2003. The economy did dip though I looked at the Shanghai Composite Index from 11/1/2002 to 7/31/2003. The Shanghai dipped from approximately 1,520 to 1,320 in November and December but promptly rallied back to the 1,510 level in January before going sideways. In short, it was nothing but a buying opportunity. Again I can’t predict the future and the loss of life is exceedingly unfortunate. Maybe this spirals into the end of human civilization, but I’m taking the under. Thus far, I’ve seen one sell side analyst recommend buying shares of travel related stocks due to the severity of the drop. If history repeats itself ,buying the dip looks like a wise strategy.

H-Share Update 

The Hang Seng slumped -1.52%/-128 index points to close at 27,909 as volume jumped 16.9% day over day and well above the 1-year average. Breadth was awful with only 1 advancer and 49 decliners led lower by Tencent -1.38%/-42.4 index points, China Construction Bank -1.23%/-25.8 index points, and Ping An Insurance -1.61%/-25.7 index points. Hengan International was the day’s only positive stock making it easily the best performer +1.49%/+1.9 index points while China Unicom was off -5.6%/-6.9 index points after releasing disappointing earnings with healthcare stock Sino Biopharma the day’s second worst performer -4.62%/-11.1 index points. . Chinese stocks in Hong Kong were off -1.99% while Hong Kong companies were off -1.37%, using the HS China Enterprise and HS HK 35 as proxies. The Chinese stocks listed in Hong Kong within the MSCI China All Shares Index were off -2.2% led lower by discretionary -3.82%, real estate -3.46%, tech -3.46%, industrials -2.94%, healthcare -2.84%, materials -2.68%, energy -2.37%, financials -1.76%, communication -1.58%, staples -1.56% and utilities -0.95%. Southbound Connect is closed until next Friday.

A-Share Update 

Shanghai & Shenzhen were hammered -2.75% and -3.45% as volume jumped +14.7% day over day and well above the 1 year average. Breadth was atrocious with only 290 advancers and 3,457 decliners. There was no place to idea today though mid and small caps did worse than large caps. The mainland stocks within the MSCI China All Shares were off -3.51% as real estate -4.08%, materials -3.95%, staples -3.94%, tech -3.92%, discretionary 3.85%, energy -3.65%, financials -3.38%, industrials -3.19%, utilities -2.62%, healthcare -2.62% and communications -2.55%. Northbound Connect volumes were very high as foreign investors dumped Mainland stocks. Both Shanghai and Shenzhen experienced elevated volumes as sellers outpaced buyers. Foreign investors sold $1.697 billion of mainland stocks today. Northbound Connect trading accounted for just over 5% of Mainland turnover, which is above average.

Appliance maker Midea Group (000333 CH) was off -4.14% after Hong Kong Stock Exchange suspended buy orders in the Stock Connect program due the stock having reached the foreign ownership limit. Foreign investors can still sell the stock, which they did today in advance of the stock being removed from MSCI indices effective tomorrow. Early last year Han’s Laser (002008 CH) was kicked out MSCI indices for the same reason though the company missed earnings sparing investors a significant drop (the stock ultimately came back off its lows). The foreign ownership limits need to be changed. The timing in advance of MSCI’s end of February 2020 inclusion schedule will raise the significance of this issue. Midea is geared to China’s consumer, which is an area of investor focus. I don’t see the issue of raising the foreign ownership limit to 49% for SOEs and to 100% for privately held firms. At the same time, why didn’t the company issue more stock? Regardless, the issue should be addressed and put to bed.

TAL Education (TAL US) had another broker defend the stock post earnings Tuesday.

Last Night’s Prices & Yields

  • USD/CNY 6.93 versus 6.91
  • CNY/EUR 7.68 versus 7.65
  • Yield on 1-Day Government Bond 1.43% versus 1.54%
  • Yield on 10-Year Government Bond 2.99% versus 3.03%               
  • Yield on 10-Year China Development Bank Bond 3.43% versus 3.46%
  • Commodities were lower on the Shanghai & Dalian Exchanges with Dr. Copper -0.66%