China's sudden stock rally is draining money from the rest of Asia

(Bloomberg) — A strong rally in Chinese stocks is expected to trigger a shift in global portfolios as some investors look to quickly capitalize on the rally.

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A wave of money that had previously abandoned Chinese stocks in favor of those from Japan and Southeast Asia is threatening to reverse course following Beijing's latest stimulus drive, market observers said. The shift is already underway: stocks in South Korea, Indonesia, Malaysia and Thailand saw net outflows last week, while BNP Paribas SA said over $20 billion was withdrawn from Japanese stocks in the first three weeks of September.

The beginning rotation could mark the end of a steep rally for Asian ex-China stocks, which previously benefited from asset managers looking for better returns outside the world's second-largest stock market. Taiwanese stocks have rallied for much of this year as chipmakers soared, while Indian stocks rallied on the back of accelerating economic growth. Markets in Southeast Asia were boosted by lower US interest rates.

“We are reducing our long positions across Asia to fund China purchases,” said Eric Yee, senior portfolio manager at Atlantis Investment Management in Singapore. “Everyone does it. It's a good, politically driven recovery from rock bottom. You don’t want to miss this opportunity.”

The MSCI China index has risen more than 30% from its recent low as authorities announced a flurry of measures to revive growth. Trade turnover in China and Hong Kong hit a record high on Monday.

Attractive reviews also helped. Despite the recent rally, the MSCI China indicator is still trading at 10.8 times forward earnings, below its five-year average of 11.7.

According to EPFR data at the end of August, global mutual funds have a total exposure to Chinese stocks of 5%, the lowest level in a decade, underscoring the scope for funds to add to their holdings.

“We believe some foreign investors are reducing their overweight in Japan and shifting back to China,” BNP strategists including Jason Lui wrote in a note on Wednesday.

To be clear, the transition is still in its early stages and BNP notes that there has been no significant outflow of foreign funds from India and products from emerging markets outside China.

Some, like Jeffrosenberg Chenlim, an analyst at Maybank Investment Bank Bhd., view the flow of funds as “a temporary event.” An indicator of Hong Kong-listed Chinese stocks fell as much as 4.9% on Thursday, snapping a 13-day winning streak.

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Although it is early days, “there could be an argument for a rotation from Japan or India to China,” said Mohit Mirpuri, fund manager at SGMC Capital Pte. Ltd. based in Singapore. “China will be the frontrunner by the end of 2024. The current dynamic is difficult to ignore.”

(Adds analyst commentary, index moves in tenth paragraph)

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