Chinese markets in turmoil as Russia joins risk list

(Bloomberg) — Global investors are losing faith in China’s ability to navigate an increasingly complex maze of challenges.

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The war in Ukraine raises the specter of severe sanctions against Chinese companies if they decide to acquire stakes in Russian energy and materials producers. The risk of Chinese companies being delisted from the United States is increasing. A real estate crisis is worsening. Record commodity prices locally could fuel inflation, while the highest Covid-19 infections since the outbreak in Wuhan will weigh on already weak consumption.

President Xi Jinping’s crackdown on the most profitable companies had already undermined investor sentiment before the Russian war. Since the invasion, pessimism has turned into panic. A gauge of Chinese stocks in Hong Kong plunged 15% in the world’s worst performance among actively traded benchmarks. The country’s junk bond yield soared above 25% for the first time. Sovereign debt was not immune to selling, with the 10-year yield hitting its highest level since December.

While sanctions have weighed more heavily on Russian assets, Chinese markets are the ones that matter globally. The Russian stock market was valued at $781 billion at the start of the year, compared to $19 trillion for mainland China and Hong Kong stock exchanges. Chinese companies make up almost a third of the widely followed MSCI Emerging Markets Index, compared to less than 4% for Russia before the index compiler reclassified the country. China’s onshore debt market is worth around $21 trillion.

“The capitulation is starting to happen,” said Gilbert Wong, quantitative strategist at Morgan Stanley, whose team predicted the rout of Chinese stocks last year and held back from joining the bullish consensus on China at the end of the year. approaching 2022.

The crisis of confidence is a challenge to Xi’s primacy, especially in a year when he plans to cement his third term as president. Xi has strengthened his ties with Russia, as stated in an extraordinary joint statement with Vladimir Putin shortly before the invasion. Both leaders have made it clear that they have closed ranks against the West, saying there is no limit to the friendship between the two nations.

While China continued to provide diplomatic support to Russia after the invasion, officials in Beijing also expressed concern over civilian casualties, vouched for Ukraine’s sovereignty and stepped up diplomacy with European nations while calling for peace talks. It is also unclear what financial support China will provide to Russia, with US Commerce Secretary Gina Raimondo saying there is no evidence that Chinese companies plan to evade US sanctions against Russia.

China remains extremely dependent on Western capital and technology, despite recent efforts to make the country more self-sufficient. Foreign direct investment topped 1 trillion yuan ($128 billion) last year, about a third of it in high-tech sectors, Chinese Commerce Minister Wang Wentao said this month. Xi told attendees of the World Economic Forum in January that he welcomes all types of “legal” foreign investment.

For many Western companies, the allure of China is fading. According to a US Chamber of Commerce survey released this month, US companies are reluctant to increase investment due to growing regulatory uncertainties, pessimism about market access and concerns about economic growth.

Global investors have even less conviction and are backtracking. Foreign investors sold more than $5.7 billion of onshore stocks this week thanks to trade links with Hong Kong, the most since March 2020. The Hang Seng China Enterprises Index is trading at levels seen for the last times in 2009, while a gauge of US-traded Chinese stocks has fallen almost 70% since peaking last year.

Losses could get worse from there, according to Morgan Stanley analysts, including Jonathan Garner, who rightly called the peak of China’s stock market bubble in 2015. The MSCI China index could drop to around 62 points at the end of the year in a bearish scenario, implying a 26% annual loss – even worse than the 22% fall of 2021 – according to a note earlier this month.

The risk that a united West will harden its attitude towards China is growing. Norway’s $1.3 trillion sovereign wealth fund said this week it was excluding Chinese clothing company Li Ning Co. from its portfolio over concerns the sportswear maker could contribute to serious human rights abuses. man in Xinjiang.

Investors are worried about the possibility of Chinese companies being expelled from US stock exchanges. The U.S. Securities and Exchange Commission this week identified five Chinese companies that could face delisting if they fail to meet certain audit requirements, confusing Chinese ADR holders.

The flow of global capital to Chinese sovereign debt is also beginning to reverse. Foreign investors sold $5.5 billion net of bonds in February, the highest on record and the first outflow in 11 months. Notes have fallen almost daily for the past two weeks, with yields on benchmark 10-year sovereign debt hitting 2.86%. Goldman Sachs Group Inc., Pacific Investment Management Co. and AllianceBernstein Holding have recently become less bullish on Chinese bonds.

This could undermine China’s efforts to fund fiscal spending to meet this year’s 5.5% growth target. Total issuance is likely to be 7 trillion yuan in 2022, according to Standard Chartered Plc estimates, with much of the supply likely in the first half of the year. China’s increasingly strained banking system is expected to sacrifice lending to absorb supply, leaving foreign buyers with an increasingly important role to play in the market, said Craig Botham of Pantheon Macroeconomics.

“This year, China has probably found enough money at the bottom of the couch to get things done in a reasonable way,” Botham, the Hall of Fame’s chief China economist, wrote in an email. “That will erode over the course of the year though, and the closet looks empty from 2023. Someone will have to borrow.”

The economy will likely need a lot of support. The housing market is cooling rapidly, home sales have been falling since July and developers are increasingly facing defaults.

The average yield on China’s junk dollar bonds – dominated by property companies – hit a record high of 25.8%, according to a Bloomberg index, reflecting growing pessimism about companies’ ability to repay debt.

According to Bloomberg Intelligence analysts Dan Wang and Daniel Fan, a record 56% of developers’ offshore high-yield notes were trading below 50 cents on the dollar. More than 30% of banknotes could default this year, analysts say.

Domestic consumption is low as the country struggles to control the spread of omicron. Next week’s data will likely show retail sales rose just 3% year-on-year in the first two months, according to the economist’s median estimate. Efforts to keep Hong Kong Covid Zero have failed this year, leading to a spike in cases and one of the highest death rates in the world.

Chinese Premier Li Keqiang, announcing his final year as the country’s No. 2, said on Friday that the economic growth target for 2022 will be a challenge. After saying that China would become more open to foreign investment, Li waved goodbye and said “thank you all” in English.

(Updates to add detail on China’s reaction to the war in the seventh paragraph.)

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