China’s stock rally for the ages shows the power of crowds

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The fiery rally in Chinese stocks over the past week underscores one of the key rules of the markets: Always keep an eye on the crowd.

Shortly before an extended market holiday, Beijing authorities sent a firm message that enough is enough. The economy is stalled (by Chinese standards – most Western economies would be happy with growth rates just above 4.5 percent) and the stock market has been shutting down for months.

So the central bank and other authorities have unleashed a raft of recovery measures, from interest rate easing, to easier requirements for banks to shed reserves, to direct efforts to stimulate the stock market and the promise of fiscal support that follows. Are these tax measures super detailed? Not. Will a small fraction of a percentage point in interest rates change the long housing sector? Also no. But do retailers care about that? Again, no.

The result is therefore a rally over time. The CSI 300 index of Chinese shares has risen more than 20% in less than a week. Hong Kong’s Hang Seng is now the world’s best-performing major market this year, up 30 percent, compared with 19 percent in the U.S. S&P 500.

Timing played a role here – the general assumption was that Beijing would hold out for some time before taking something like this. Scale matters, too; Deutsche Bank says the fiscal stimulus is a “big deal” which, measured against the size of the economy, is the country’s third largest ever – a Mario Draghi-style “whatever it takes” moment.

It could be months before we know the real economic impact. But the markets don’t wait to find out. That’s because before this injection of support, investors were just allergic to China. Bank of America’s regular survey of fund managers found last month that “macro pessimism has centered on China,” with growth expectations at their lowest point in the three years the bank has tracked them in this form.

Around the same time, I spoke to Amundi’s chief investment officer, Vincent Mortier, who said he had “never seen such pushback” from clients against the idea of ​​putting money to work there. He argued that it was unwise to avoid China entirely, but the conversation did not begin. The bet was “totally, totally dead,” he said.

Pity the hedge fund manager who told me this week that he almost took this as a trigger to buy China but backed out. As any good professional investor will tell you, when everyone seems to hate a certain corner of the global markets, it’s time to buy. But it can be hard to work up the courage.

This is not the first time this year that positioning power has been made clear, the other prime example being Japan. In its quarterly review of markets earlier this month, the Bank for International Settlements noted that “concentrated hedge fund positions” played a key role in the speed and size of Japan’s “turbulence” in early August.

Carry trades – selling currencies with low interest rates and buying those with higher rates – were unusually popular among hedgers in the run-up to the August revolution, the BIS said. In the 2022 period, that meant there was a lot of speculative money buying dollars at the expense of the yen — a force that helped push the yen to its lowest point in decades. Placed trades and related bets on US stock market volatility have become an unusually strong influence on hedge fund returns.

At the same time, speculators gravitated toward buying Japanese stocks. Everything was fine until, in early August, it suddenly wasn’t. A US growth scare that raised expectations of interest rate cuts hit these strategies on several fronts, hurt the dollar, particularly against the long-held yen, and fueled equity volatility. Outputs from this correlated set of transactions were found to be congested on output.

Cue an alarming drop in the dollar-yen exchange rate and, on a particularly scary Monday, a double-digit drop in the Japanese stock market — the biggest decline since the Great Crash three decades ago and casting a shadow over “ buy Japan” thesis became popular. “Crowding, combined with high leverage, has set the stage for increased stress and spillovers across assets,” the BIS report said.

Other examples are easy to find, such as the massive build-up of bets on US chipmaker Nvidia – a stock that became overcrowded over the summer and lost a third of its value in six weeks.

With all this in mind, it’s worth looking for the points of greatest investor consensus now, just in case it makes sense to take the other side. For example, the same BofA survey that said China is a contrarian buy also indicated buying commodities, which investors are shunning to the greatest extent since 2017.

Thematically, the biggest point of consensus is for a soft landing in the US economy – an expectation held by nearly 80% of fund managers. So many smart people can’t all be wrong about something, right?

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