(News Bulletin 247) – One of Hong Kong’s flagship indices briefly entered a bear market on Tuesday, amid growing doubts about the recovery of the world’s second largest economy. Diplomatic tensions between Washington and Beijing add to this climate of mistrust.

The mood is gloomy in the Chinese markets. Investors in the Middle Kingdom are gray before crucial data on the Chinese manufacturing sector for the month of May.

And early indications of the manufacturing sector in China’s second-largest economy are concerning. Chinese factory activity is likely to have contracted further this month, according to a Reuters poll on Monday. “Sentiment around China continues to be bearish ahead of the May manufacturing PMI to be released on Wednesday,” UBS analysts were quoted as saying by Reuters. These numbers give a relatively reliable snapshot of the health of the Chinese economy this month. In April, manufacturing activity in China had already unexpectedly declined. These figures already highlighted the difficulties facing the Chinese economy.

The Hang Seng China Enterprises Index lost as much as 1% on Tuesday, marking a fifth day of decline. It even briefly lost 20% compared to its peak of January 27 at 7773.61 points, a threshold from which the market is generally qualified as bearish (or “bear market”). This is a worrying signal, with the Hang Seng China Enterprises Index serving as a benchmark to reflect the overall performance of mainland Chinese stocks listed in Hong Kong.

Meanwhile, China’s benchmark CSI 300, which includes stocks listed in Shanghai and Shenzhen, has plunged more than 10% from its peak this year.

Monday, the places of Hong Kong and Shanghai had already fallen heavily to flirt with their lowest level since the beginning of the year. Quoted by AFP, Michael Hewson, an analyst at CMC Markets, noted “concerns about the economic recovery in China, with recent economic data suggesting that confidence is falling and economic activity is in decline”.

Fears in the real estate market

The real estate market is also the focus of investor fears as home sales have fallen by more than a third from pre-pandemic levels. The record unemployment of young Chinese, one in five of whom is now unemployed, also calls for caution.

In addition to these concerns about the country’s economic recovery, a new diplomatic crisis between the United States and China is also rekindling tensions. Beijing recently rejected a US request for a meeting of defense chiefs at an upcoming security forum in Singapore. Quoted by the Financial Times, Louis Tse, managing director of the brokerage firm Wealthy Securities, explains: “It’s the economy, yes, but it’s also more than that”.

It is therefore difficult for investors to be positive on China given these headwinds. “There is just no positive news and it’s really difficult for investors,” said Willer Chen, principal analyst at Forsyth Barr Asia Ltd, quoted by Bloomberg.

Foreign funds reduce the airfoil

As a sign of this mistrust, American and European fund managers do not want to hold Chinese assets in their portfolios at the present time. They have reduced their exposure to mainland Chinese equities for the second consecutive month, reports Bloomberg.

“Domestic fund sales fell to levels close to those seen after the market crash in 2015 as investors remained risk averse,” the Shanghai Securities News quoted the news agency as reporting on Tuesday.

However, the gradual reopening of the Chinese economy at the start of the year had raised a wave of hope in the markets after a complicated 2022. On January 8, China officially lifted quarantines for people entering Chinese territory, effectively ending three years of zero-Covid-19 policy. Witness the flow of buyers of foreign funds to China, which peaked in January 2023.

“While global growth will experience a considerable weakening in 2023, the Chinese economy will register an upward trajectory. This exceptional decorrelation, linked to the end of the zero-Covid strategy and the strong support of fiscal and monetary policies, is very good. bodes well for Chinese equities. […] Investors will not be able to do without this allocation to generate a little magic and prosperity in their portfolios during the year of the rabbit”, explained Atlantic Financial Group.

Without substantial support from the Chinese state, the recovery will remain weaker than expected and the economy is likely to continue to underperform, explains the FinancialTimes Winnie Wu, Chinese equity strategist at Bank of America.

“We expect 2023 to be a year of weak economic recovery, given China’s already high debt-to-GDP ratio, tight local government fiscal situation and long-term challenges in the real estate market,” Wu said.