18 January 2016

For eight days in a row starting in December 2015, the People’s Bank of China (PBoC) weakened the yuan reference rate, culminating in a 0.5% devaluation of the currency on 7 January and triggering market sell-offs around the world.

The magnitude of the 0.5% move may look small in absolute terms but it is, in fact, quite significant – it’s the largest one-day move since the sudden devaluation on 11 August 2015, according to Bloomberg data. In response, the China onshore equity market plunged 7% after the first 30 minutes of trading, halting stock trading for the second time in the first four days since a new ‘circuit breaker’ mechanism had been put into effect. Chinese regulators have since announced a suspension of the circuit breaker mechanism for an indefinite period of time to allow for further study and improvements.

After trading halted, the China Securities Regulatory Commission (CSRC) announced that major shareholders could not sell more than 1% of a company's shares on the open market within a three-month period starting from 9 January, essentially extending a ban of stock sales by major shareholders that was set to expire last Friday. The CSRC now also requires major shareholders to disclose any equity disposal plan 15 days in advance.

Where next for the renminbi?

We maintain our view that moderate depreciation against USD will be likely in 2016, but we expect to see broad stability of RMB against a trade-weighted basket of currencies.  We think that the current weakening may be a pre-emptive move to prepare for currency impact related to further Fed rate hikes to come, but view the timing right after the recent A-share weakness as being somewhat unfortunate.

What’s the outlook for Chinese equities?

Market sentiment has soured dramatically towards the A-share market, even though the CSRC looks like it will be proactive in seeking to stabilise sentiment.  Along with the rest of the market, we were somewhat surprised that the circuit breaker was triggered twice in the first four days of being operational – the thresholds of 5% and 7% were probably set too tight for the A-share market given its historical volatility level.  As a reference, the US circuit breaker thresholds are set at 7, 13, and 20% while Korea’s are set at 8, 15, and 20%. Some adjustments are required ahead of it being reinstated.

In the offshore equity market, we feel that the pessimism is well-priced in in the Hong Kong listed stocks. Higher volatility is expected in the near term, but with better structural improvements already put in place over the last couple of years (and further improvements may be on the way), we believe that if Chinese regulators successfully achieve a soft landing, we may see a better environment for H-shares than we have had over the past five years.

How are you adjusting portfolios?

We remain constructive on H-shares where we see better relative value. We prefer accessing Chinese stocks via the offshore markets and only have very limited exposure to the A-share market (less than 0.6% in any of our funds). We stay focused on selecting stock specific exposure in both new and old economy stocks that can benefit from China’s structural reforms, but are cautious on adding exposure in what is a very volatile market.

CARS ref: RSM-2843
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 12/01/2016 and may change as subsequent conditions vary.

Source: BlackRock. All data as at 08/01/2016.

In the offshore equity market, we feel that the pessimism is well-priced in in the Hong Kong listed stocks.