Talk about mistimed trading: Bears on Chinese equities just missed the biggest sell-off in seven years.
Short sellers abandoned their bearish bets against the biggest A-share ETF listed in the US just as mainland stocks tumbled the most in January since the global financial crisis.
Shares borrowed and sold on expectations of a decline in the exchange-traded fund fell to a one-year low of 4.2% of stock outstanding on January 11, down from a record of 38% on December 9, according to data compiled by Bloomberg and Markit. The trades were unwound as the fund, which tracks the CSI 300 Index of companies traded in Shanghai and Shenzhen, lost as much as 28% from a peak in late 2015 through last week.
Traders gave up on their bearish wagers on the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF in December after losing money during a four-month rally fueled by speculation policy makers would add new stimulus measures following a $5tn August stock rout. Scaling back on the short sales backfired when signs of weakening growth and surging capital outflows from China combined with a failed circuit-breaker programme triggered mainland markets’ descent into a bear market in January.
“You did see a lot of people missed the selloff,” Drew Forman, co-head of trading at Macro Risk Advisors, a brokerage of equities and options, said by phone last week from New York.
The combination of changes in investors’ outlook on China’s stock markets and the high cost to borrow the ETF for bearish trading may have contributed to the drop in short interest, according to Dodd Kittsley, head of ETF strategy and national accounts in New York at Deutsche Asset and Wealth Management.
The cost to borrow the ETF to short it reached a high of 10 in December, the most expensive level on a scale provided by Markit, a London-based research firm. It’s currently rated 7. Investors pulled $46mn from the fund in the three weeks through January 28, helping cut total assets to about $300mn.
“From our understanding, the changes of short interest are driven by the changes of shares outstanding, sentiment around China and the borrowing cost,” Kittsley said.
Bearish traders are returning to the fund now. Short interest in the ETF has more than doubled in the past two weeks to 9% of shares outstanding, the data show. The fund fell 5.4% to $22.17 in the five trading days through January 29, trading near a 14-month low. The benchmark Shanghai Composite Index fell 23% in January, the most since October 2008.
Betting against the ETF has been a profitable trade in the past. Short sellers in the US-listed ETF were rewarded seven months ago after more than doubling their bearish wagers in the two weeks leading up to the peak in June. Short interest reached 15% of shares outstanding the day the market topped out on June 12, a record at the time. The ETF and the Shanghai Composite both fell more than 40% in the subsequent crash, a selloff that was only halted after the government’s intervention.
China’s financial markets have become notoriously volatile and difficult to forecast amid a string of government interventions, according to Wayne Lin, New York-based money manager at QS Investors, whose firm oversees $18bn assets including Chinese stocks.
“China is still a semi-closed speculative market,” said Lin, “It’s very hard for the underlying value to drive the investment decisions.”
Investors follow financial information at a securities brokerage in Shanghai. The benchmark Shanghai Composite Index fell 23% in January, the most since October 2008.
