(Bloomberg) — President Xi Jinping’s efforts to regain the trust of international investors face serious hurdles.
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Xi’s government showed little regard for the same investors last year when it unleashed a series of crackdowns on the country’s most profitable companies, in a bid to curb “disorderly capital” and ensure the firms didn’t become more powerful than the Communist Party. The result was confusion and punishing losses for shareholders. Regulators have yet to follow through on promises made this month to ensure policies are more transparent and predictable.
Wariness toward Chinese assets has only increased since Russia attacked Ukraine just weeks after a Beijing summit reinforced the close ties between Xi and Vladimir Putin. Global investors feared the Biden administration would hit China with similar penalties, even though American officials say China has complied with U.S. sanctions and there’s no evidence to suggest otherwise.
While there’s little doubt Chinese assets are cheap — the MSCI China Index of stocks trades near the biggest discount to global peers in more than two decades — for many investors, the downsides of China exposure outweigh the potential upside. The trauma of investing in Russia, where sanctions and capital controls made internationally-held assets effectively worthless, has prompted investors to look at China in a different light.
“There’s a very thick layer of political risk over Chinese assets right now,” said Daniel Murray, Zurich-based chief executive officer of EFG Asset Management in Switzerland. His firm manages and advises on about $50 billion. “You could wake up and see China has done something to really complicate things, like providing military equipment to Russia or something. President Xi falls into the strong-man camp of global leaders which is not a popular club at the moment.”
Such decoupling by global capital adds to risks facing Xi at a time when the spread of Covid and a property slump are undermining the outlook for the world’s second-largest economy. The volatility threatens to spill over to the real economy ahead of a key party meeting later this year at which Xi is set to trumpet China’s global leadership and extend his decade-long rule.
Capital flight is a growing concern. The Institute of International Finance reported an “unprecedented” surge in outflows from China starting in late February, when Russia’s invasion of Ukraine began.
In the third week of March, redemptions from China equity funds were the highest since early 2021, while outflows from Chinese bond funds exceeded $1 billion for the first time ever, according to data provider EPFR Global. Foreign selling of the nation’s sovereign bonds last month totaled $5.5 billion, the most on record and ending 11 months of inflows.
A rout in Chinese stocks listed on overseas exchanges was briefly halted after Beijing took coordinated action to address some of the biggest concerns by foreign investors. These included pledges to ensure stability in capital markets, support overseas listings, resolve risks around property developers and complete the crackdown on Big Tech “as soon as possible.”
“The recent speculation driven rally is unlikely to be sustainable,” wrote Morgan Stanley strategist Gilbert Wong in a Tuesday email. “It was contributed by contrarian trades and quarter-end window dressing activities. We reminded investors — and traders — to book profits in this rally, and hedge for a potential out-sized market move in the second quarter.”
A recovery in Chinese stocks was one of the most popular calls among Wall Street strategists going into this year. Cheap valuations, easier monetary policy and the peaking of Beijing’s regulatory crackdown would finally attract money to the country’s markets, they argued. While the strategists weren’t wrong in their reasoning — and most have stuck to those views — they overestimated the willingness of global funds to deploy money to China.
Chinese exchange-traded funds saw $3.7 billion in redemptions last week even as Asian markets like Taiwan and South Korea attracted foreign inflows, according to Citigroup Inc. Long-only investors with a global equity mandate now allocate just 2% of their portfolios to stocks in China and Hong Kong, Morgan Stanley’s quantitative strategy team wrote in a March 24 note.
The MSCI China was trading at about 1.4 times book value when the 2022 outlooks by Wall Street banks started coming out in mid-December. The multiple fell as low as 1.1 times this month, the lowest in data going back to 2000. The MSCI All-Country World Index trades at 2.8 times book.
Bulls point to potential stimulus as reasons to buy.
“China’s ties to Russia have created a geopolitical stigma risk that could pressure some investors to avoid Chinese assets,” wrote BlackRock Investment Institute strategists led by Wei Li in a note dated Monday. “We stay moderately overweight Chinese stocks as we see a shift to easier policies across the board.”
Yet authorities have been cautious about throwing money around. The People’s Bank of China unexpectedly held a key policy rate in March, even as some of its broad-based tools to spur liquidity and drive economic growth are becoming less effective.
Xi’s pledge to reduce the economic damage of his Covid Zero strategy is looking increasingly challenging as lockdowns in cities like Shenzhen and Shanghai cost the country an estimated $46 billion a month, or 3.1% of GDP, in lost economic output.
“So far, authorities have promised support but not delivered any new stimulus,” said Thomas Thygesen, SEB AB’s head of cross-asset strategy in Copenhagen. “That’s probably a fundamental driver of outflows.”
Attracting foreign capital has long been one of Xi’s priorities as he sought to make China’s financial markets more efficient and boost the international usage of the yuan. Since he became president in 2013, the government opened stock and bond trading links with the rest of the world via Hong Kong and successfully pushed for the inclusion of yuan-denominated assets in major global benchmarks.
Such efforts paid off. Since the end of 2013, overseas holdings of local stocks increased by more than 1,043% to 3.9 trillion yuan ($612 billion), central bank data as of December shows. Inflows into the nation’s bond market rose by 925% to 4.1 trillion yuan in the period.
Xi reiterated China’s commitment to opening up in January at a time when his policies were being criticized by foreign investors including billionaire philanthropist George Soros.
“All types of capital are welcome to operate in China in compliance with laws and regulations and play a positive role for the development of the country,” Xi told the World Economic Forum via video link at the time.
But Xi can no longer count on the greed of investors to own a slice of his country’s growing economy. The question is whether China can still suck in global capital in a world where entire country holdings can be written down to zero almost overnight.
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