Shanghai Composite Index slumps another 0.9% to two-year low

Hong Kong

GLOBAL passive funds are buying China's domestically traded shares for the first time and it is not going well.

Stocks in Shanghai have tumbled 13 per cent in dollar terms since MSCI Inc added so-called A shares at the start of the month.

Only equities in Argentina and Namibia have performed worse. Worries about a slowing economy, tightening liquidity and a possible trade war are plaguing the world's second-largest stock market, while a suddenly tumbling currency is only adding to foreign investor losses.

While MSCI's decision to initially allocate a minuscule weighting to so-called A shares will limit the fallout, the almost US$2 trillion rout is evoking uncomfortable echoes of Chinese market panic just three years ago.

A repeat of such turmoil, even on a lesser scale, is likely to undermine efforts in Beijing to encourage foreign inflows and stabilise a market still dominated by speculators.

"The timing is very awkward," said Anthony Chan, chief investment strategist for Asia at Union Bancaire Privée. "There's still a lot of guessing as people try to price in changes to growth expectations."

There is little sign that the outlook for Chinese shares will improve any time soon.

The Shanghai Composite Index, already in a bear market and at its most oversold since 2013, slumped another 0.9 per cent on Thursday to a two-year low.

Average daily turnover on mainland exchanges this month has fallen to the lowest since August 2014, suggesting buyers are thin on the ground.

That is bad news for the exchange-traded funds, international retirement plans and endowments that track an MSCI index.

The declines are also stinging foreign funds who took advantage of greater access to Chinese equities via links in Hong Kong.

Overseas investors bought a net US$13.5 billion of mainland shares since the start of May through mid-June. The purchases are almost equal to the total bought for during the first four months of the year.

Foreigners have had better luck with the nation's government bonds. The benchmark 10-year yield fell 10 basis points in a fifth monthly decline, the longest streak since 2015, as investors sought refuge from the stock market and bets increased that the central government would loosen liquidity.

Easing would however add to selling pressure on the yuan, already down 3.3 per cent in June, making Chinese assets less attractive. The currency was 0.4 per cent lower on Thursday at a seven-month low. BLOOMBERG