(Bloomberg) -- When it comes to Chinese equities, the dominant feeling has turned to optimism.
The nation’s bazooka stimulus announced last week has pushed a gauge of Chinese stocks traded in Hong Kong to its best weekly surge in almost 13 years, putting it on track to become one of the world’s biggest gainers for 2024. What’s more, market participants chasing the rally have sent the cost of volatility hedges over the next month spiking to a two-year high relative to six-month contracts, indicating confidence for the medium term.
In just a few days, China boosted measures to spur everything from consumer spending to the housing market and local equities. The Hang Seng China Enterprises Index, which earlier this month was barely up for the year, rebounded more than 22% in 11 consecutive days, its longest streak of gains since its glory days of 2018.
“It seems like this time the Chinese government feels the urgency to change,” said Michael Oh, a San Francisco-based portfolio manager at Matthews Asia. “The rally can continue if investors are convinced that the Chinese government will continue to support the market. The Chinese market was just too cheap.”
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Shares of the nation had been struggling as a slew of disappointing economic data had made investors skeptical it would meet its annual expansion target of 5%. Earlier this month, the China Enterprises index’s valuation came close to 7 times estimated earnings for the next 12 months — compared with more than 8 times for the five-year average.
But everything changed last week. China cut interest rates, the banks’ reserve ratio and borrowing costs; pledged billions of dollars to boost equities; announced handouts to spur consumer spending; and even rolled out support to local milk production.
As stocks rallied, protecting against declines in the China Enterprises gauge became the cheapest since 2015 — the year the gauge reached a multiyear high. At the same time, the number of bullish contracts outstanding hit its highest level since June relative to bearish ones.
In the US, where investors including billionaire David Tepper were among those buying Chinese securities, trading of options on exchange-traded funds tracking the Asian nation’s stocks surged. Bullish bets dominated, with some early call buyers taking profits later in the week and others rolling positions through call spreads. Trading of short-term contracts on American depositary receipts of Chinese companies was bullish.
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The sudden spike in volatility could reverse if the rally peters out, warned Chris Murphy, co-head of derivatives strategy at Susquehanna International Group.
“Investors looking to hedge the move via buying puts should be very careful of a situation where prices pull back but implied volatility levels also drop, severely limiting gains on long puts even if the underlying drops,” he said. Buying put spreads, protective collars or overwriting to reduce exposure makes more sense, he added.
Marc Franklin, senior portfolio manager for asset allocation at Manulife Investment Management, says that even though concerns remain over the mainland’s economy in the longer term, now optimism prevails.
“We expect a meaningful short-term rally in Hong Kong and China stocks markets owing to the very cautious investor positioning, which creates the potential for a sharp short-covering led bounce,” Franklin said.
--With assistance from Natalia Kniazhevich.