China small-cap stocks boosted by state rescue package as 220 million individual investors gain confidence in outlook

The CSI Small-cap 500 Index is up 15 per cent from the start of February, compared with a 10 per cent gain for the benchmark CSI 300 Index
Hopes for further policy loosening and a lull in economic data releases mean ‘the moment on small-caps has yet to run its course’, analyst says

China stock market

Zhang Shidongin Shanghai

Published: 2:01pm, 4 Mar 2024

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Chinese small-capitalisation stocks have been beating the country’s largest companies, adding to signs that investor confidence is on the mend since Beijing intensified its efforts to stem a market rout.

The CSI Small-cap 500 Index has risen 15 per cent from the start of February when a slew of rescue measures – including the appointment of a new boss for the securities regulator and direct state buying – were put in place. The CSI 1000 Index of a wider array of smaller companies has climbed 13 per cent in the span. Meanwhile the CSI 300 Index of the largest companies has risen 10 per cent.

The turnaround in small caps, a barometer of retail sentiment, signals growing buying interest from the nation’s 220 million individual traders, fuelling optimism that the rebound driven by the policy support has legs. Smaller companies previously bore the brunt of the sell-off due to risk stemming from leveraged financial derivatives issued by brokerages, known as snowball products.

Expectations about further policy loosening set off a frenzy on liquidity-sensitive small-caps, and a lull in the release of economic data has investors placing event-driven thematic investments in stocks linked to artificial intelligence (AI) and humanoid robots, according to Fu Jingtao, a strategist at Shenwan Hongyuan Group in Shanghai.

People practice tai chi in front of buildings in Pudong’s Lujiazui Financial District in Shanghai on February 19, 2024. Photo: Bloomberg

“Thematic trades have been pretty active, and that is fuelling the breeding ground for small-caps,” he said. “Given the wealth effect from the sector, the moment on small-caps has yet to run its course.”

China’s major commercial banks made the biggest cut on record to a key lending rate tied to mortgage rates last month. Meanwhile, official data on retail sales, industrial production and investment in January and February is not due for another two weeks; the nation’s statistics bureau does not publish separate data in the first two months of the year because of seasonal distortion by the Lunar New Year holiday.

The recent slide in government-bond yields may reinforce investors’ bets on smaller companies, whose returns typically move inversely with debt yields. The 10-year sovereign bond currently yields 2.36 per cent, close to an 18-year low of 2.353 per cent in February on mounting expectations about a further reduction in borrowing costs.

Some investors remain cautious about the outperformance of smaller companies, citing their disadvantages versus large companies in valuations and profitability. Small-cap stocks will probably face headwinds as increased new listings diminish their value as potential targets for reverse mergers and the regulator cracks down on manipulation and continues efforts to delist unqualified companies, according to Li Bei, founder of hedge-fund firm Shanghai Banxia Investment Center.

The preference for smaller companies in mainland China diverges from the global trade pattern. In the US, small-caps have been in the doldrums amid tight financial conditions, massively underperforming the “Magnificent Seven”, including Nvidia and Amazon, which offer exposure to the booming AI business.

The strong performance of China’s small-caps compared with larger companies stretches over the past three years. The CSI 500 dropped 7.4 per cent last year and the CSI 1000 lost 6.3 per cent, while the CSI 300 slid 11 per cent. In 2021 the two small-cap gauges rose at least 15 per cent against a 5.2 per cent loss for the CSI 300.

Small-cap companies tend to post faster earnings growth when the economic outlook improves, while mature ones see slower growth rates.

“Thematic trades simply mean that the run in small-caps is in the very early stage,” said Wang Yang, an analyst at Zheshang Securities. “For the rally to sustain, you’ll need to see significant growth in earnings and an uptick in the economic cycle.”

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