Foreign investors sold Chinese equities for the fifth month in a row, but the outflows narrowed significantly

Executive Summary:

Foreign investors withdrew from China onshore equities for the fifth consecutive month. The continued reduction of foreign holdings stems from the fact that many people have more than a short-term focus on the actual profitability of enterprises due to the medium- and long-term impact of the complexity of macro issues. But we have observed that the worst of foreign outflows may be behind us. The sell-off by foreign investors will drag down the stock market for a while, but the larger decline also provides investors with an opportunity to make profits.

1. Foreign investors withdrew from China's onshore stocks for the fifth consecutive month

The South China Morning Post on November 30, 2023, said in an economic news item that overseas traders sold a total of 1.78 billion yuan ($250 million) of renminbi stocks in November, plus a net sale of 131 billion yuan in the previous four months. Foreign investors pulled out Chinese onshore equities for the fifth consecutive month in November, extending record capital outflows due to a lack of confidence in the strength of the recovery in the world's second-largest economy.

Executives at Switzerland-based GAM Investment said international investors' trading in Chinese stocks was driven by macro issues, and many people were no longer focused on corporate earnings in order to close deals and leave the market as soon as possible.

On the same day, Bloomberg data also showed that overseas traders sold a total of 1.78 billion yuan ($250 million) of renminbi-denominated stocks on mainland exchanges through the Stock Connect program in Hong Kong, making the cumulative net selling of 127 billion yuan that had lasted for three months increase. These four months of outflows are the longest continuous outflows since the Shenzhen Stock Exchange joined the cross-border investment program in December 2016.

The outflow reflects not only a lack of confidence in the market, but also a lack of key investment themes to support the market. Nomura Holdings said in its recent research note that while upcoming economic data may show a higher year-on-year growth rate in November, this is mainly due to the low base caused by the lockdowns. Real economic growth is likely to decelerate by the end of the year and early 2024, which will drive macroeconomic decisions to fund struggling property developers, the Japanese brokerage said.

Second, the continuous reduction of foreign investment stems from the fact that many people have more than a short-term concern about the medium- and long-term impact of the complexity of macro issues, which has exceeded the short-term focus on the actual profitability of enterprises

The latest economic data shows that the mainland's economic recovery is fragile and uneven. Official purchasing managers' indices showed that both manufacturing and services contracted more than expected in November. Among them, the mainland manufacturing purchasing managers' index (PMI) unexpectedly fell 0.1 percentage points to 49.4% from October, declining for two consecutive months, and continued to be in the contraction zone; the business activity index of the service industry fell 0.8 percentage points from October to 49.3%, following the manufacturing PMI fell into the contraction area last month, the service PMI also slipped into the contraction area, which is also the first time that the service industry fell to the line of prosperity and withering this year.

While the growth of industrial production and retail sales in October seems to have exceeded economists' consensus expectations, in fact, it is simply because economists who made the forecasts generally ignored the low base effect of production and consumption in October last year, which suffered from the sudden tightening of epidemic restrictions. At the same time, exports shrank for six consecutive months, and the decline in real estate investment deepened. The high-stakes meeting between China and the United States has helped to establish risk management, but it has not helped to boost market sentiment, as the key issues affecting us such as tariffs and technology export restrictions remain unresolved, and there is no sign of easing in the near term.

As of the end of September, Jian Shi Cortesi, investment director of GAM Investment in Switzerland, which manages $74 billion in assets, also said in his latest Eastern Economic Research Report that "international investors' trading in Chinese stocks is driven by macro issues, and the complexity of macro issues has outweighed many people's short-term concerns about actual corporate earnings."

Jian Shi Cortesi poses a series of questions in his research report: Imagine if I were a pension fund in the West, I would have a lot to take on. Would I spend five hours learning about China's real estate market? Probably not. On the downside, it was quickly concluded that the first reaction to risky markets should be to stay away.

Third, the reduction in the scale of the sell-off means that the worst of foreign capital outflows may be over

But on the other hand, the data also brings good news. The size of the sell-off by foreign investors in November was the lowest in four months.

Generally speaking, there are two possibilities for a sudden reduction in the size of the sell-off:

First, the chips in the hand have been sold out, and there is nothing to throw. According to the scale of domestic stock assets held by foreign institutions and individuals of 3,329.6 billion yuan in June 2023 announced by the People's Bank of China, minus the reduction of foreign holdings in the last July and the last four months reported by Bloomberg, as of the end of November, overseas institutions and individuals still held 3,196.7 billion yuan of domestic stock assets. Obviously, it's not unavoidable.

Second, the bearish foreign institutions have basically emptied the stocks they plan to empty. This suggests that the worst of foreign capital outflows may be behind us.

If foreign investors have basically emptied the stocks they plan to vacate, it means that in fact, in the long run, foreign investment in China's stock market will remain stable. In fact, at the end of November, the 3,196.7 billion yuan of domestic stock assets held by overseas institutions and individuals were basically the same as the 3,196 billion yuan of domestic stock assets held by overseas institutions and individuals in December 2022.

As a result, some of the world's largest fund managers, including Fidelity International and Franklin Templeton, have recently issued a call in their recent research reports to warn investors to watch for a turnaround in China's stock market as the government provides more support to revive economic growth and equity valuations are attractive.

Fourth, the sell-off of foreign capital will drag down the stock market for a period of time, but the large decline also provides investors with opportunities to make profits

With the recovery not clear, the foreign sell-off is likely to continue to weigh on China's stock market for some time, offsetting managers' efforts to shore up the market. For example, a 50 billion yuan (US$7 billion) joint private equity fund, planned by two state-owned insurance companies, invests in renminbi-denominated stocks.

China's CSI 300 index fell 2.1% in November, falling for the fourth consecutive month and down 9.7% year-to-date. Eight of the 10 industry groups on the indicator posted losses this month, with materials and industrial stocks falling at least 4.3%, the worst performers.

The FTSE China A50 Index also fell from 12,976.97 points at the end of last year to 11,756.05 points on November 30, a cumulative decline of 9.4% in 11 months. Compared with the end of June, before the large-scale reduction of foreign investments, the FTSE China A50 Index has fallen by 5.9% in the last five months, far exceeding the 3.3% decline in the first half of the year.

However, the deeper decline means that this round of bottoms has been revealed, and while the current signal shows no signs of a reversal, even the upcoming rally in the downcycle provides investors with an opportunity to make profits.

[Author: Xu Sanlang]