China's biggest stock buying spree in years is overwhelming the stock market

(Bloomberg) — Chinese stocks capped their biggest weekly rally since 2008 with a burst of trading that overwhelmed the Shanghai Stock Exchange and underscored a dramatic shift in investor sentiment after Xi Jinping's government stepped up economic stimulus.

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Echoing the rally that followed China's massive stimulus measures during the global financial crisis, the CSI 300 index of large-cap stocks rose 4.5% on Friday, bringing this week's gain to 16%. Trading activity was so intense that it caused disruptions and delays in order processing, according to people familiar with the matter. The Shanghai Stock Exchange said it was investigating the issues, without elaborating.

It was a tumultuous end to a week that raised hopes of a bottom for China's $8.9 trillion stock market, after years of losses that have made it one of the world's weakest bourses. Chinese authorities unleashed a long-awaited flood of monetary stimulus on Tuesday, followed by a pledge from top politicians to do whatever is necessary to support the housing market and boost consumption.

While many details of China's economic stimulus remain unclear and past periods of euphoria have often fizzled out, market observers say fears of missing out on a sustainable recovery are palpable. With China's markets closed next week for the Golden Week holiday, domestic investors may fear that Hong Kong's rally could continue in their absence, said David Chao, a strategist at Invesco Asset Management.

“FOMO is high for investors as Chinese stocks are up nearly 10% in the last three days,” he said. “Based on historical valuation, we believe Chinese stocks still have another 20% to go.”

An indicator of Chinese stocks in Hong Kong rose 3%, snapping its longest winning streak since 2018. The ChiNext index, a tech-heavy indicator, rose a record 10%. Sales on the mainland topped 1.4 trillion yuan ($200 billion), reaching their highest level in three years despite trade woes. Sales in Hong Kong reached 445 billion Hong Kong dollars (US$57.2 billion), the highest level on record. Meanwhile, U.S.-listed Chinese companies were poised to extend gains at the open as they rallied in premarket trading on Friday.

As investors turned to risky assets rather than safe havens, China's ultra-long government bond futures posted their biggest daily loss on record on Friday. China's 10-year bond yield rose 5 basis points to 2.16%.

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The rally also hit a number of quantitative hedge funds in China hard, people familiar with the matter said. Some firms suffered losses because they shorted index futures for their so-called direct market access strategies, the people said, requesting anonymity because the matter was private. In some cases, losses were exacerbated by the stock market disruption that left them unable to sell their holdings to meet margin requirements, another person said.

The shift by Chinese authorities this week prompted billionaire investor David Tepper to declare that he is buying more of “everything” related to the country. “I thought that what the Fed did last week would lead to monetary easing in China, and I didn't know they would bring out the big guns like they did,” he said Thursday in a CNBC interview. “We have a little longer, more Chinese stocks.”

Securities regulator guidelines designed to encourage companies to attract long-term investors also added to the optimism already brewing in the market.

Underscoring Friday's broad rally, 266 of the 300 members of the CSI 300 Index ended the day in the green, with liquor maker Kweichow Moutai Co. and battery maker Contemporary Amperex Technology Co. leading the advance.

But Chinese bank stocks defied the rally, falling as investors weighed the impact of a 1 trillion yuan ($142 billion) capital injection plan reported by Bloomberg News. China plans to inject funds, mainly from issuing new special government bonds, the report said, citing people familiar with the matter.

The injection plan could result in a 56 basis point dilution in return on equity, JPMorgan analysts including Katherine Lei wrote in a note. The drop could also reflect a move away from sectors that were seen as more resilient during the market decline; With some of the highest dividend yields in the country, Chinese banks are attractive to investors looking for stable returns.

Some investors are looking for signs of further fiscal stimulus to fuel the next phase of earnings. “We can also expect fiscal measures,” said Raymond Chen, fund manager at ZiZhou Investment Asset Management. “It certainly leaves a lot of cynics behind.”

Morgan Stanley is among a number of China watchers starting to turn bullish, with strategist Laura Wang and colleagues seeing another 10% upside potential for the CSI 300 index in the near term. Just days earlier, the Wall Street bank abandoned its preference for onshore stocks over offshore stocks, citing the lack of supporting factors such as government purchases.

Optimism also lifted other Asian stocks with exposure to the world's second-largest economy as risk appetite increased across the region.

– With support from Winnie Hsu, Abhishek Vishnoi and Subrat Patnaik.

(Updates to add quantitative hedge funds in eighth paragraph.)

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