Friday, December 30, 2016

A Year In China Markets: Yuan Down, Stocks Down, Bonds Faltering

Currency heads for steepest annual depreciation since 1994; Strategists see stocks rebounding after this year’s retreat.

By Sarah McDonald and Helen Sun
December 30, 2016

The China market scorecard doesn’t make for great reading this year.

The yuan: down the most since 1994. Stocks: down the most since 2011. Bonds: clinging on to the smallest return in three years. But for some assets at least, strategists see prospects of a turnaround. The following is a summary of China’s markets this year, and the outlook for 2017.

Weakening Yuan

The yuan started the year by torpedoing global markets, with a series of weaker-than-expected fixings in early January creating panic about the nation’s currency policy and spurring capital outflows. Even as the central bank changed tack to prop up the exchange rate with intervention, capital controls and verbal support, the yuan ended up falling 1.3 percent on the month, the biggest January decline since its peg to the dollar was scrapped in 2005.

While the currency’s impact on world investor sentiment has waned since then, its trajectory versus the dollar has been much more consistent. The yuan has weakened in eight months this year, including four out of the past five, and is set for a 6.5 percent slide against the greenback, the most in two decades.

Against a basket of currencies, introduced by officials a year ago as part of efforts to decouple the yuan from the greenback, the picture looks brighter. The yuan rose to a four-month high versus the group on Dec. 20. China this week diluted the role of the dollar in the trade-weighted basket and added a further 11 members.

In 2017, markets and analysts are in agreement on the yuan’s direction. There’s a 62 percent chance for the Chinese exchange rate to weaken to 7 per dollar by the end of the first quarter, more than quadruple the probability seen three months ago, options prices show. The currency will end 2017 at 7.15, according to analysts’ median forecast in a separate Bloomberg survey.

Sinking Stocks

As far as starts go, it could hardly have been worse for the world’s second-largest stock market. By the end of January, the Shanghai Composite Index had plunged 23 percent to rank bottom of 94 global equity indexes tracked by Bloomberg, roiled by concern about the economic outlook and the government’s stewardship of the yuan.

As stocks slowly clawed their way back, taking more than nine months to extend their rebound to 20 percent and enter a bull run in November, investors experienced a rare period of calm in what had frequently been the world’s most volatile major equity market.

That serenity has shown signs of cracking in December, with the Shanghai Composite down 4.6 percent this month and set for the biggest annual drop since 2011, yet analysts are keeping the faith. The share measure will climb to 3,800 by the end of next year, according to the median forecast in a Bloomberg poll, implying a 23 percent gain from Thursday’s close.

“Weak growth momentum and external market performance weighed on stocks this year,” said Wei Wei, a Shanghai-based analyst at Huaxi Securities Co. “These concerns will probably continue to be in place going into next year. However, with the economy stabilizing, we expect to see more opportunities in stocks next year.”

China’s official factory gauge matched a post-2012 high in November, corporate profits are rising, and factory-gate inflation has accelerated to the fastest pace in five years.

Fragile Bonds

About the only place where investors have seen gains this year is in the bond market, with a broad gauge of Chinese debt returning 1.3 percent as coupon payments made up for a decline in bond prices, according to Bank of America Merrill Lynch.

Still, even there it’s been a bumpy ride of late. China’s bonds are down 1.7 percent in December as efforts to reduce risk in the financial system exacerbate a liquidity squeeze. The yield on 10-year sovereign securities now sits at 3.05 percent, versus 2.82 percent at the end of last year.

Money market rates are set to rise further in the first quarter, according to the median estimate in a Bloomberg News survey of 24 bond traders, investors and analysts. More than half the respondents are expecting the selloff in China’s $7.9 trillion debt market to last until at least the end of March, with the government’s deleveraging push and tighter monetary conditions looming as the biggest risks, and onshore property bonds are seen as the riskiest investments.

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