China’s smallest stocks are sounding a warning about potential downsides for the world’s second-largest equity market if Beijing fails to deliver on a much-anticipated rescue campaign. Despite the large-cap CSI 300 Index managing a 0.7% gain on Monday following regulatory promises of market support, small-cap shares plummeted over 6% to their lowest level since 2018. The CSI 1000 Index has suffered a 27% loss this year, marking the most significant underperformance against larger peers in over nine years, especially notable after a challenging January.
This underperformance suggests that investors are abandoning small-cap shares, anticipating that policy support will prioritize rescuing blue-chip stocks. There’s speculation that state funds may have intervened, given record trading volumes observed in some exchange-traded funds tracking the CSI 300 gauge.
Vincent Chan, China strategist at Aletheia Capital Ltd., noted, “The market currently relies on support from the national team, and investors see the big caps as their buying target. This discourages small-cap investors from holding onto their position as they don’t have the downside protection.”
Quantitative hedge funds are suspected to have exacerbated the recent selloff, prompting authorities to impose bans on some of them from placing sell orders. The market’s fragility is evident in the CSI 300 wiping out all gains since late last month when a 2 trillion yuan ($278 billion) support plan was under consideration as part of a stock stabilization fund.
Liu Yuhui, an academic at a government think tank, stressed the need to establish a stock stabilization fund to boost market confidence, aiming for a size of 10 trillion yuan or more.
With the approach of the Lunar New Year holiday, investors are preparing for potential losses to deepen. Concerns about geopolitical tensions and sluggish consumption may contribute to further selloffs once trading resumes.
Daisy Li, fund manager at EFG Asset Management HK Ltd., commented, “It’s looking very difficult for the next few days as sentiment is extremely fragile, and many in the market would choose to cut positions before the Chinese New Year. The market is waiting for more forceful policy stimulus to restore confidence and the economy, which we think is more likely to come later in the second quarter.”
New risks have emerged, including margin calls, forced liquidation, and selling pressure linked to so-called snowball derivatives. The CSI 1000 gauge, a benchmark for snowballs, has plunged as these products hit knock-in levels, incurring losses for investors.
While the China Securities Regulatory Commission pledged to prevent abnormal fluctuations and guide more medium- and long-term funds into the market, the downward pressure is expected to persist unless more decisive measures are taken to address the confidence crisis affecting the markets.
Sat Duhra, portfolio manager at Janus Henderson Investors, emphasized, “Actions such as state buying are not conducive to restoring confidence, which is the key here. We are not adding or reducing the current position, which is about 9% underweight.”
