China’s falling bond yields steal the spotlight from stock-market bulls
The yield spread between the Shanghai Composite Index and the 10-year Chinese government bonds has widened by the most since October 2016
The return from China’s sovereign bonds beat the nation’s stocks by the most in 18 months, as traders seek shelter in safer assets with the economic outlook clouded by a looming trade war.
While declines in equity prices push up the earnings yield on the nation’s US$7.4 trillion stock market, gains in the 10-year government bond have driven down its yield since November. The yield spread between the benchmark Shanghai Composite Index and the 10-year bond has widened the most since October 2016, according to data at the end of April compiled by Bloomberg.
The rotation into bonds from stocks underlines the increasing odds that growth at the world’s second-largest economy will moderate after the US threatened tariffs of US$150 billion and barred Chinese telecom equipment maker ZTE from buying crucial American technology. United States Trade Representative Robert Lighthizer on Tuesday played down optimism that the two sides will reach a quick deal before a delegation flies to China for negotiations this week.
“The market is in a risk-off mode,” said Wang Zheng, chief investment officer at Jingxi Investment Management in Shanghai. “The risk of a trade war is hanging over the stock market and talks between China and the US will probably fall through, given the current news flow. The trend of bonds outperforming stocks is likely to continue.”
The Shanghai Composite has dropped 13 per cent from its January high, driving up the earnings yield on the index to 6.7 per cent, while the return on the 10-year bond stood at 3.67 per cent, down from a high of 4.03 per cent in November.
Stocks still look expensive relative to bonds as a two-year run-up in equities, particularly among large companies, has stretched valuations, according to Hong Hao, managing director with Bocom International Holdings in Hong Kong. Once the pattern that bonds are favoured over stocks is established, historical data shows it should remain in place for a while, he said.
“For now, with a slowing economy and limited inflation pressure, it is likely that the trend of falling long bond yields and falling stock prices will persist,” Hong said.
Increased volatility as well as the lack of intervention by state-backed funds has also weighed on stocks this year. The 60-day price swing on the Shanghai Composite has risen to the highest level in almost two years after dropping to a record low in 2017, Bloomberg data showed.
Still, there is optimism among investors who believe negative factors weighing on stocks are temporary. Howard Wang, the Hong Kong-based head of Greater China Equities at JPMorgan Asset Management, said trade tensions between the US and China will be smoothed over time.
“By the end of this year, this will be viewed as a transient correction moment in a sustained bull market that remains supported by powerful fundamental growth factors,” he said.
The implications of the trade friction on corporate earnings are being gauged by traders and analysts. A potential trade war would lower earnings growth for mainland-listed companies excluding financials by as much as 1.6 percentage point, according to UBS Group.
“It’ll be difficult for stock investments this year and bonds would be a better place to put money,” said Wang at Jingxi Investment.