The View | As bullish foreigners pile into China’s stock markets and local investors remain bearish, who is right?

Since its peak in late January, the Shanghai Composite Index has plummeted nearly 21 per cent, an even sharper fall than the one suffered by the main equity index in Turkey, one of the most financially vulnerable emerging markets.

As recently as September 14, the Shanghai Composite was trading below its post-bubble trough in January 2016 and stood at its lowest level since late 2014. While mainland stocks have rallied over the past fortnight, the severe headwinds bearing down on Chinese shares – the dramatic escalation in the trade war and a slowing domestic economy – remain firmly in place.

Yet, since the beginning of this year, investor sentiment in China’s equity markets has become remarkably bifurcated. While domestic retail investors, who account for some 85 per cent of the trading on the Shanghai and Shenzen bourses, remain resoundingly bearish, foreign institutional investors have been piling into mainland stocks.

According to new data from Bloomberg, foreigners have bought a net US$29 billion of onshore shares through Stock Connect, the trading link connecting bourses in China and Hong Kong, since the beginning of this year, a stark contrast to the capital flight in 2015-16 triggered by the surprise devaluation of the yuan.

Global funds are being drawn to China’s equity markets – the world’s third-largest after Japan’s – for a number of reasons, which include a local currency that is at its cheapest level against the US dollar since May 2017 and significantly lower costs for investors to hedge their portfolios against a further decline in the yuan, partly due to the rapidly narrowing gap between interest rates in the United States and China.