The Wall Street Journal-20080128-Turning Defensive in China- Some See Tumult Ahead- Adopt -Short- Strategies
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Turning Defensive in China; Some See Tumult Ahead, Adopt 'Short' Strategies
Full Text (511 words)Hong Kong -- Skeptics see more of the sheen coming off China's markets this year, and investors are on the prowl for strategies that break away from last year's buy-anything philosophy.
Chinese markets have been a beacon in the region even as the subprime mess and fears of a U.S. recession have put a dent in global markets. Still, they are down about 10% this year and likely to come under more pressure, say those turning bearish on the market.
As China implements tightening measures to correct imbalances in its trade surplus, fend off inflation and deal with declining exports to a slowing U.S. economy, its stock trading is apt to see more zigs and zags.
The recent turmoil that took a bite out of most Asian markets hit China hard. In Tuesday's Asian rout, the Shanghai Composite index sank 7.2%, after a 5% drop the day before, while Hong Kong's Hang Seng index fell 8.7%. After a hefty U.S. interest-rate cut, markets rebounded. The Shanghai index climbed for three straight sessions, but still ended with a weekly loss of 8.7%. Hong Kong lost 0.3% over the week.
Given the volatility, one strategy some investors have adopted is to indirectly "short" shares. Normally, short sellers sell borrowed shares in hopes of buying them back for less after the price declines. Because it is illegal to short mainland-listed shares, or Class A shares, some investors have been shorting exchange-traded funds that track the domestic Chinese markets. Others are taking short positions in Hong Kong-listed Chinese companies.
Still others are holding on to long positions in more defensive sectors and putting their faith in the Chinese consumer.
Inflation, at its highest level in 11 years, is becoming a serious issue for policy makers. Any measures to control it -- let the yuan appreciate, increase reserve ratios at banks, raise interest rates -- will hurt more as exports to the U.S. and Europe are slowing.
"In the past, they could grow their way out of the problem," but with global growth slowing, "it's a dilemma with no easy way out anymore," says Robbert van Batenburg of Louis Capital Markets, an agency brokerage whose clients include hedge funds. Mr. van Batenburg, one of the biggest bears, sees China's Shanghai and Shenzhen markets declining 20% to 50% this year from Jan. 22 levels. Add in slower post-Olympics infrastructure spending and there could be "a major correction in the overinflated Chinese stock market," he says.
With a forecast of about 10.5% growth in gross domestic product in 2008, China's economy is hardly in dire straits. But any slowdown is likely to be felt in earnings and the stock market. Goldman Sachs recently trimmed its forecast for economic growth in 2008 to 10% from 10.3%.
Another risk to earnings is reduced investment income. Last year, the Shanghai Composite jumped 96.7%. A repeat this year is considered unlikely. "In lots of listed Chinese corporates, up to two-thirds of their earnings are coming from investment-rated activities," says James Chirnside, director at Asia Pacific Asset Management, a fund of hedge funds.
