Hedge Funds Rapidly Sell Off Chinese Stocks

January 24: A Perfect Call

On January 24, we informed our premium subscribers that Chinese stocks had experienced a significant and rapid drop, suggesting it was an opportune time to invest in China through FXE. Looking back, this advice was perfectly timed, marking the lowest point for Chinese equities. Several months later, Wall Street, always a step behind, began to show strong interest in China, albeit with more risk and less potential for profit.

May 6: The Time to Sell

Fast forward to May 6, when we concluded that Chinese stocks had once again moved too far, too fast. We advised our subscribers to close their FIX trades, as we also closed our long China position, yielding a 25% profit in just over three months. This advice also proved to be almost perfectly timed. After a slight increase beyond our sell level, Chinese stocks have since fallen, and it seems that others have also begun to sell off their Chinese stocks.

Hedge Funds Follow Suit

As noted by Goldman's John Flood in his daily Chart of the Day, the latest Goldman weekly Prime Brokerage data reveals that "Hedge funds unloaded Chinese stocks across all channels last week and at the fastest pace since last summer." After seven weeks of net buying Chinese equities (albeit modestly), Hedge funds have reversed course and accelerated their selling.

Chinese Equities Sold Off

As demonstrated in the Goldman PB chart, Chinese equities were collectively sold for a second consecutive week on the Prime book, with last week's notional net selling being the largest since August '23. Chinese stocks were sold across all channels, primarily through ADRs and H-shares, indicating a more cautious approach due to signs of an uneven recovery in economic activity. From a positioning perspective, exposures in Chinese equities are currently low, with Gross/Net allocations (as a percentage of the overall Prime book) sitting in the 6th/8th percentiles on a 5-year lookback.

Goldman's Constructive Stance and Subsequent Reversal

Interestingly, this reversal occurred just after Goldman published a note last week, stating that it had adopted a "constructive" stance on Chinese stocks, foreseeing more upside. This was a significant change from their previous bearish outlook on China that extended well into 2024. However, as Goldman's sellside research is often used as a punching bag for its in-house traders, this marked the point when China's stocks took a hit.

More Downside to China

Despite this, we foresee even more downside for China. Flood notes that "the pullback hasn't changed our core views/thesis on China equity, if anything, it provides a better entry point for investors to capitalize on China's rising portfolio value (i.e., diversification benefits), downside policy put underwritten by the government, and upside optionality on capital market reforms." In other words, it may be wise to wait until Goldman turns bearish before reinvesting in Chinese stocks, as most of the good news, including the latest housing bailout, has already been factored into the price.

Final Thoughts

The rapid sell-off of Chinese stocks by hedge funds is a fascinating development in the world of finance. It raises questions about the future of Chinese equities and the strategies employed by major financial institutions. What are your thoughts on this matter? Do you think this sell-off is a temporary blip or a sign of a larger trend? Share this article with your friends and discuss it with them. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.