Warning Signs Are Flashing in China's Stock Market After Surge

(Bloomberg) --

Investors are running out of reasons to chase the bull market in Chinese stocks.

After adding as much as $2.5 trillion to share values and outpacing gains everywhere else in the world, the rally in China is starting to look tired. Headwinds include an uninspiring earnings season, as well as the likelihood that Beijing will pursue a less aggressive stimulus policy than anticipated. Talks with the U.S. on trade also resume this week.

Some of the hottest trades have already started to unravel in the past two weeks, including brokers, small caps and stocks with links to next-generation telecom networks. Analysts say there could be more pain ahead as the Shanghai Composite Index has failed to hold above a number of key support levels. Mainland trading will be shut for a three-day holiday from Wednesday.

“The correction might be far from over,” said Shen Bifan, chief strategist with Shenzhen Spruces Capital Management Co. “It would require strong earnings and economic fundamentals, or a shift in policy, to power further gains. None of those are immediately available.”

China's official manufacturing gauge fell unexpectedly in April, data showed, adding to concerns over the country's economic health. After its worst three-day decline since October, the Shanghai Composite Index closed up 0.5 percent Tuesday.

Below are five charts showing how the world's second-biggest equity market is losing momentum.

As recently as March, Chinese equity traders were beating their global counterparts by the biggest margin since June 2015. The outperformance reversed only weeks later: the Shanghai index lost 5.6 percent in the five days through April 26, lagging the MSCI All-Country World Index by the most since January 2016.

China's momentum-driven stocks are losing steam. A gauge tracking the speed and magnitude of gains fell Monday to the lowest since early January, or just when the rally was gathering pace. The 14-day relative-strength index hasn't touched the 70 level since April 10, signaling the market is no longer overheated.

The Shanghai Composite has recently dipped below a few key levels that previously provided a floor for the gauge. It closed below 3,100 points Friday and fell below its 50-day moving average Monday, after trading above that level for most of the year.

Overseas traders, who had been keen buyers of Chinese equities through the bull market, are taking profits. They sold a net 18 billion yuan ($2.7 billion) of A shares via stock links with Hong Kong this month, data compiled by Bloomberg showed. That makes April the biggest month of outflows since the Shenzhen link started in late 2016.

Not everything is falling apart in this market. Investors are starting to buy into some of the nation's biggest caps, which often outperform in a downturn because profits are stable and volatility is lower. The big-cap SSE 50 index jumped 1.6 percent Monday, outperforming the CSI Smallcap 500 Index by the biggest margin since November 2017.

--With assistance from Richard Frost.

To contact Bloomberg News staff for this story: Amanda Wang in Shanghai at twang234@bloomberg.net;Amy Li in Shanghai at yli677@bloomberg.net

To contact the editors responsible for this story: Sofia Horta e Costa at shortaecosta@bloomberg.net, Philip Glamann

©2019 Bloomberg L.P.

With assistance from Bloomberg