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China investors see silver lining for stocks as bonds tumble

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For some China investors, the outlook for bonds is becoming a compelling reason to buy stocks.

[SHANGHAI] For some China investors, the outlook for bonds is becoming a compelling reason to buy stocks.

December's debt selloff, the biggest in six years, may just be the start as policy makers crack down on speculative trading, according to HFT Investment Management Co With the Shanghai Composite Index one and a half years on from its own bubble bursting, and fresh from its steepest annual decline in five years, fund managers and strategists say stocks are finally offering some relative value.

"We prefer equities to bonds in the first half," said He Qian, a Shanghai-based portfolio manager at HFT, which oversaw 189.4 billion yuan (S$39.3 billion) of assets as of Sept 30. "The market expectation is that inflation will continue to recover, and that'll benefit risky assets in the initial stages. Plus, there are other positive factors including improving corporate earnings."

Like their counterparts around the world, China's investors are grappling with the re-emergence of inflation as a threat to debt returns and a tailwind for equities, with factory-gate prices rising last month at the fastest pace in five years. Plus, other economic reports from industrial profits to manufacturing support the argument that equities have an edge, and policy makers' efforts to boost money-market rates are spoiling a long-followed strategy of using borrowed cash to buy bonds.

Still, in the first weeks of January, neither asset class is proving a fertile ground for investors. Government bonds have declined, with the 10-year yield jumping 25 basis points to head for the biggest monthly advance since March 2015. The Shanghai Composite has edged 0.5 per cent higher, after a 4.5 per cent tumble in December that was the most in 11 months.

The big shift began in August, with the People's Bank of China guiding borrowing costs higher as a nine-year credit binge aiming at boosting economic growth pushed China's debt-to-gross domestic product ratio to 247 per cent.

The central bank began extending the tenors of its open-market operation loans, which halted a record bond rally and pushed a Bank of America Merrill Lynch index of Chinese debt down by 1.7 per cent in December.

The benchmark 10-year sovereign yield climbed to a 16-month high of 3.37 per cent on Dec 20, after touching a record-low 2.64 per cent in August. The earnings yield for Shanghai shares is around 1.3 percentage points higher than that for corporate bonds due in a decade. The figure shrank to 1.19 per cent in December, which was the smallest gap since August 2015.

China's gross domestic product expanded 6.8 per cent in the fourth quarter from a year earlier, more than the estimate of 6.7 per cent in a Bloomberg survey, Friday's data showed.

Yield on 10-year sovereign debt due November 2026 fell three basis points to 3.24 per cent on Friday, data compiled by Bloomberg show. That compares with a 200-day moving average of about 2.89 per cent.

It's a bearish sign when the yield rises above its long-term moving average, said Hao Hong, Hong Kong-based chief strategist at Bocom International Holdings Co.


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