| HONG KONG, Sept 30
HONG KONG, Sept 30 In early July, long-depressed
Chinese stocks stepped into the unlikely role of stars among
emerging markets. But the outperformance has ended, and it's
very unlikely investors will see a repeat any time soon.
At the rebound's peak in early September, the MSCI China
index of mostly offshore listings in Hong Kong was up
20 percent from June lows, while the onshore market spiked 16
Helping fuel that rally was a spate of reassuring data that
considerably improved views of the Chinese economy. Also, China,
with its closed capital system, was seen as a relatively safe
haven among emerging economies, whose growth is threatened by
more capital outflows when the U.S. Federal Reserve cuts its
But the recent rally reflected mainly a reduction in extreme
bearishness on the Chinese market, and hence an improvement in
share valuations, rather than a foundation for sustained
"It's not the beginning of a trend reversal," said Joseph
Tang, who as Invesco Asia's investment director helps manage
$1.3 billion in a series of China-focused funds. "It's too early
to say if China equities have entered a long-term up trend."
Ahead of a one-week closure of mainland markets for National
Day that starts on Tuesday, China shares trimmed gains and some
with large recent gains have been hit by profit-taking. Still,
the MSCI China index has risen more than 10 percent in the third
Long-term domestic issues clouding the outlook for offshore
Chinese shares include growing indebtedness of companies,
industrial overcapacity and still-soft growth.
It was a spike in mainland interbank lending rates in late
June that raised fears of serious grief in the world's
second-largest economy, triggering a slide in global markets.
The rally effectively began after the People's Bank of China
intervened by ordering larger banks to lend to smaller banks and
by promising to stabilise the market. A slew of positive July
and August economic data, along with the approval of a Shanghai
free trade zone, spurred further gains.
While some investors were concerned about missing the rally,
"there has not been any real change in their outlook on China,"
said David Cui, Bank of America-Merrill Lynch's Shanghai-based
chief China equity strategist.
Already, capital flows data suggests the interest in Chinese
equities remains sluggish. Short selling interest in Hong Kong
has remained largely above the 8 percent historic average
According to a Sept. 30 Macquarie report citing data from
funds tracker EPFR, China-dedicated funds saw fund outflows
intensifying in the week that ended Sept. 25 in a 19th
consecutive week of outflows.
From conversations with clients, Cui said global macro funds
appeared to remain the most pessimistic on China and that much
of the recent interest in Chinese equities has been centered on
the banking sector.
Shares of mid-sized lender China Minsheng Bank,
among the hardest hit at the height of the cash crunch, have
rebounded nearly 30 percent in Hong Kong from a June trough.
Now up more than 4 percent on the year, Minsheng's H-share
listing is now approaching normalized valuation, trading at 1
time book value, despite being some 12 percent below its
historical median, according to Thomson Reuters StarMine.
The broader market is trading at a similar valuation. The
MSCI China index is at about 10 times forward 12-month earnings,
according to Thomson Reuters I/B/E/S data. This is still one
standard deviation below its historical mean, suggesting that
valuations remain cheap.
"China market (at) 9 times P/E is too cheap... 10 or 11
times would be a fair level," said Byhungha Kim, who as co-chief
investment officer at Mirae Asset Global Investment manages $2.2
billion in a series of onshore and offshore China funds.
While this might suggest more near-term gains are possible,
several risks lurk.
Ominously, the final reading of a private survey on China's
factory activity in September came in at 50.2 on Monday, an
unusual downgrade to a preliminary reading last week that came
in at 51.2, suggesting that manufacturing likely grew at its
fastest pace in six months.
Offshore Chinese markets are also vulnerable to a pullback
in the onshore market after the third plenary session of the
18th National Congress in November, a policy meeting where
China's new leaders usually set out economic priorities for
their 10-year term.
(Editing by Richard Borsuk)