September 24, 2019

Danger Grows as China's Hottest Stocks Get Increasingly Crowded

Trouble is brewing in multiple indicators measuring how many companies are keeping the stock market aloft in China.

Only about a third of firms on the CSI 300 Index have outperformed the gauge this year, the smallest proportion in any rally year since 2009. Some 10 stocks account for roughly half of the returns, including enormous stocks like Kweichow Moutai Co. and Ping An Insurance (Group) Co. Foreign investors are compounding the problem by buying the most liquid megacaps.

The concentration is resulting in a particularly distorted picture of this year’s bull market. With few stocks underpinning the rally, the risk is that any sudden reversal in China will be particularly painful. Momentum trades cracked earlier this month in stock markets from New York to Sydney.

Just one-third of the 300 companies on the CSI 300 have outperformed the gauge this year, the smallest proportion in any rally year since 2009, according to data compiled by Bloomberg. This compares with about half on the S&P 500 Index in the U.S. and on the Stoxx Europe 600 Index.

The CSI 300 has rallied more than 30% this year, but half of those returns come from just 10 stocks. “A high level of crowding increases the risk of a reversal in the near term,” Goldman Sachs Group Inc. strategists including Sunil Koul wrote in a note last week. Credit Suisse Group AG strategists recommended reducing exposure to A shares this month, citing concerns about “expensive structural growth stocks”.

Funds have flowed into sectors such as consumer staples and stocks linked to next-generation wireless technology, as investors bet on companies that can generate stable earnings growth despite a slowing economy and trade uncertainties. A measure of consumer staples has rallied 78% this year, the most among 10 industry groups on the CSI 300 Index. In contrast, a measure of energy stocks -- the worst-performing sector -- rose less than 4%.

Firms involved in developing China’s fifth-generation of cellular network technology are among investors’ favorites. WUS Printed Circuit Kunshan Co. and Shennan Circuits Co., which make printed circuit boards vital for a spectrum of electronics, surged to record highs on Monday. Their stock prices have more than doubled this year.

Overseas investors keep targeting the same stocks, helped by an increased weighting of mainland-listed shares in global benchmarks. Almost half of this year’s $168 billion yuan ($23.6 billion) of foreign money flowed into the 20 most popular A shares, according to data compiled by Bloomberg. On Monday, however, foreigners sold a net 1.5 billion yuan of the shares, the most in nearly a month.

Potential triggers for a reversal next month include the start of the quarterly earnings season and any signals on monetary policy from the central bank, according to Sun Zheng, an analyst at China Development Bank Securities.

Zhang Gang, a strategist at Central China Securities Co., says investors will keep chasing this year’s stock-market darlings for now, despite the high valuations.

“There are very limited choices in the market,” he said.

— With assistance by Mengchen Lu