China equity ETFs are in free fall on wavering investor confidence that the Chinese government will be able to strengthen the market and foster growth.
In the past year, China had been the best-performing stock market in the world, thanks largely to government intervention, but now as the crack deepens, the hardest-hit ETFs are those that own mainland-listed stocks and/or small-cap securities.
Consider the performance of funds such as the Deutsche X-trackers Harvest CSI 500 China-A Shares Small Cap ETF (ASHS | D-73). In the past seven days, the fund has dropped by nearly a third. In the past month, that decline exceeds 40 percent.
Similarly, the Market Vectors ChinaAMC SME-ChiNext ETF (CNXT | D-51), the KraneShares Bosera MSCI China A Share ETF (KBA | D-59) and the iShares MSCI China Small-Cap ETF (ECNS | D-25) are down 19 to 26 percent in the past week alone, as the chart below shows:
Chart courtesy of StockCharts.com
The Chinese government had been fueling the stock market with some $20 trillion in savings in a "last-ditch effort to revive flagging economic growth by giving the country's debt-laden companies a new source of financing," Ruchir Sharma, head of emerging markets for Morgan Stanley, said today in an opinion piece for the Wall Street Journal.
"The aim was to trigger a slow and steady bull run, but the somnolent stock market exploded into one of the biggest bubbles in history," Sharma said. "Trust in China's ability to command and control the economy is faltering. If trust collapses, the global repercussions could be more severe than those from the Greek debt crisis."
According to Sharma, there are four signs of a market bubble, and China is at "the extreme end" on all those metrics:
- Prices disconnected from underlying economic fundamentals
- High levels of debt for stock purchases
- Overtrading by retail investors
- Exorbitant valuations
"Looming over all of this is China's massive run-up in debt, which has increased by over $20 trillion—to around 300 percent of GDP—since the global financial crisis in 2008," he added. "If Beijing can't stop the market's tumble, there could be a sudden shift in the perception of exactly how far economic growth might fall under the weight of too much debt. If that floor crumbles and the Chinese economy spirals downward, it will make the drama surrounding Greece feel like a sideshow."
No ETF has been spared from the recent decline, even if most China-focused stock ETFs have remained in the black in the past 12 months.
The best-performing funds in the past 12 months are a trio of A-shares-focused ETFs: the PowerShares Golden Dragon China (PGJ | A-21), the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR | C-60) and the Market Vectors ChinaAMC A-Shares ETF (PEK | D-62), with gains of about 70 percent each (see table below):