Chinese stocks in overheating territory

Warning signs abounded for stocks in Shanghai, Hong Kong and Shenzhen last week, with buying momentum particularly notable in the market’s most speculative segments.

While equity investors locked in gains yesterday after another round of Sino-US talks yielded no agreement on trade, China’s small caps outperformed. The ChiNext ended up 6.8 per cent for the week while a gauge of large caps was relatively flat. Speculators also chased this year’s hot 5G trade, snapping up every telecom in sight — Eastern Communications Co. jumped 10 per cent yesterday despite saying it doesn’t currently make next-generation network equipment. It was up 52 per cent last week.

The question is whether this year’s advance will hold. Optimists say valuations are still low after an awful 2018, earnings can only improve after a wave of profit warnings, and foreigners are buying. But sceptics warn that deregulation could stoke the kind of risky behaviour that triggered a meltup in 2015 — leveraged trading is already picking up.

Flight to safety

It’s an entirely different story in China’s debt markets. Data showing a slowdown in factory prices have added to concerns about the return of deflation and increased the likelihood of more easing from the central bank (Citigroup analysts expect a rate cut). That’s all ensured government bonds continue to be well bid — the benchmark 10-year bond yield remains close to 3 per cent despite surging risk appetite in the equity market.

Flight to safety is also the trade in China’s corporatebond market. Traders are piling into corporate debt with high credit ratings, as well as bonds sold by the central government and local authorities.