China Stocks Are Primed For Risk Rally To Morgan Stanley Quants
Investors in the mainland are unwinding their stock-index hedges at a significant pace, Morgan Stanley strategists said.
(Bloomberg) -- Equity traders in China are rapidly positioning for a rally in the onshore market, according to Morgan Stanley’s quantitative strategy team, which recommends clients prepare to “ride the wave.”
Investors in the mainland are unwinding their stock-index hedges at a significant pace, betting that a potential end to Chengdu’s lockdown and policies to stabilize the yuan will trigger a near-term rebound, strategists including Gilbert Wong and Ronald Ho wrote in a client note dated Sept. 12.
“Based on the historical trading pattern, unwinding of hedges amid a market decline usually implies a tactical risk rally,” the strategists said. “We suggest tactically adding upside market beta exposure.”
The team cited three factors in their algorithms that show market sentiment has bottomed. Demand to hedge via CSI 300 and CSI 500 index futures is at the lowest since October 2021, call options are far more popular than bearish puts -- a historical anomaly -- and implied volatility is low. Friday’s northbound net inflows were the strongest year-to-date at $2.1 billion, showing some offshore funds are starting to bet on a recovery.
While some investors bet the approaching twice-a-decade party congress will offer stocks a boost, expectations on the gains have been limited given the various macro headwinds.
Premier Li Keqiang last week called for more policies to drive up consumption and stabilize prices, according to a Xinhua report published Monday. Economists forecast China’s key August data including retail sales and industrial production to show continued weakness when they are released on Friday.
The CSI 300 Index rose 1.7% last week, its best performance since June. It’s still down more than 8% for the quarter amid concerns about the strength of China’s economy, with a worsening property crisis and tight Covid controls in major cities hurting sentiment.
The gauge rose as much as 0.8% Tuesday as mainland markets reopened following a holiday, while the onshore yuan strengthened as much as 0.22% against the dollar.
Futures tracking the CSI 300 and CSI 500 had an average price of 1.2% and 5.2% below spot levels as of Friday, according to Morgan Stanley’s quant team. That means the cost of hedging via index futures is lower that what traders are paying to own the indexes via exchange-traded funds. The price relationship, known as backwardation, is in the 90th percentile, they said.
(Updates to add more detail on futures positioning in final paragraph.)
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