China recovery bets grow on Beijing’s moves to stem stock rout

China’s assets are showing signs of a revival after a run of losses, and confidence is growing that the rebound isn’t a dead cat bounce.

A salvo of rescue measures in recent months has fuelled the biggest upturn in Chinese equities since Beijing scrapped its Covid restrictions in late 2022. Liquidity in bonds and stocks has improved, currency volatility is falling, and credit spreads have tightened – all pointing to a recovery that may prove to be more lasting than previous rallies.

A sustained improvement will offer investors a huge opportunity as some of the nation’s assets are near the cheapest they have ever been versus their peers while others are undervalued against some measures of cash. A recovery would also stanch the capital flight from the country and pave the way for China to lead an outperformance by emerging markets when US interest rates begin to decline.

To be clear, there’s still some caution in the market: Nomura Holdings likened the task of predicting the bottom in Chinese stocks to a “fool’s errand” while consumer demand and earnings have yet to improve. Still, there’s a growing conviction that the recovery may strengthen over time.

Nowhere is the turn in sentiment more visible than the stock market. The Hang Seng China Enterprises Index is the world’s best-performing primary gauge this month, a remarkable turnaround from last year, when it ranked among the worst laggards globally. The index has scored its biggest trough-to-peak gain since the reopening rally, putting it less than 5 percentage points away from entering into a so-called technical bull market. 

Against this backdrop, the longest ever streak of monthly outflows from mainland equities looks set to come to an end in February. Calls are growing for investors to consider picking up undervalued Chinese stocks, with market veterans such as Mark Mobius growing more optimistic due to valuations and improving return ratios.

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“Investor confidence in China, both in the short and long term, are already close to extreme levels of bearishness,” said Han Piow Liew, the head of equity derivatives at Maitri Asset Management. “There is perhaps a higher probability that these moves alleviate a crisis of confidence and create a stronger base for investors,” he said, referring to Beijing’s rescue measures.

The offshore yuan has stabilised around 7.2 per dollar after tumbling to the weakest in almost a year in September. One-month implied volatility for the dollar-offshore yuan pair is hovering near the lowest since 2022, suggesting traders are not expecting big swings in the near term.

China’s 10-year government bond yield is lingering near the lowest level since 2002 as investors bet the central bank will maintain a dovish stance to support the economic recovery. The growing confidence, along with lucrative yield pick-up in swap trades, has fuelled a resumption of inflows into the world’s second-largest bond market in the past quarter.

A move by the People’s Bank of China to lower lenders’ reserve requirement ratio in February has helped alleviate the liquidity stress in the financial system. The cost of one-year negotiable certificates of deposit, a popular short-term debt issued by AAA-rated banks, tumbled to the lowest since August 2023 this week.

China’s junk dollar bonds, dominated by property developers’ notes, saw their biggest daily gain in almost a month on Tuesday, according to an index compiled by Bloomberg. The rise followed a move by Chinese lenders to cut the five-year loan prime rate by a record 25 basis points to 3.95 per cent. BLOOMBERG