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China’s bullish start to year gains momentum as small caps soar

Investors are shifting into privately-owned stocks at the expense of more defensive state-backed giants.

The bullish mood building in China’s equity market is entering a new phase, with investors flocking to riskier stocks as trading reopened Monday.

The ChiNext Index jumped 3.3% in Shenzhen by 1:23 p.m. local time, putting it on course for the biggest two-day advance since October after its 3.5% rally the day before the Lunar New Year break. A gauge of Shanghai-traded large caps added 0.7%. The yuan dropped 0.6% as it traded for the first time in over a week.

Monday’s rally in small caps and stocks in the tech hub of Shenzhen — which was haunted by hundreds of profit warnings in recent weeks — shows investors are shifting into privately-owned stocks at the expense of more defensive state-backed giants. That’s a stark reversal of what happened for most of January. The resilience of onshore markets after the five-day holiday stands out in the wake of declines in Hong Kong.

“Following a wave of goodwill impairments and profit warnings, the worst time for small cap stocks is over,” said Xu Chi, an analyst at Huachuang Securities.

The SSE 50 Index rose 9% this year through Feb. 1 as investors piled into large firms that were likely to benefit most from Beijing’s measures to support the slowing economy. That’s more than twice the gain of the Shenzhen Composite Index, and compares with a paltry 1.7% advance for the ChiNext.

The Shenzhen Composite gained 2.4% Monday, compared with a 0.9% advance for the Shanghai counterpart.

A series of rule changes from China’s securities regulator has also encouraged greater risk-taking in the equity market. Within days of appointing Yi Huiman as its new chairman in January, the China Securities Regulatory Commission said it will scrap an automatic margin call threshold, allow a broader array of collateral to be used for certain loans, lower capital requirements for riskier assets and broaden how foreign investors can use their money.

Trade talks with the US may provide new cues this week. Chinese Vice Premier Liu He will join Treasury Secretary Steven Mnuchin and Trade Representative Robert Lighthizer in Beijing for high-level trade talks after Donald Trump said he won’t meet Xi Jinping before the scheduled imposition of additional US tariffs on Chinese goods. Trump’s advisers informally discussed holding a summit with President Xi in March in Mar-a-Lago, according to an Axios report.

Technical indicators suggest the coming weeks will be pivotal for China’s equity market after it recovered almost $380 billion this year. A gauge of momentum on the CSI 300 climbed to the highest level in 12 months before the Lunar New Year holiday, while the Shanghai Composite Index finally closed above its 100-day moving average for the first time since last February. In Hong Kong, the Hang Seng Index just rose above the 28,000 key level.

“Small and large cap stocks have been fighting for capital,” said Zhengyang Shen, a Shanghai-based strategist with Northeast Securities Co. “The SSE 50 had been outperforming before holidays and when such an outperformance reaches a certain point, some investors tend to lock in profit and switch to small caps.”

© 2019 Bloomberg L.P

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