Hao Hong: Whose Confidence Is Gold?

• Confidence of various market participants is neutral to contrarianly positive, against a backdrop of better monetary environment.
• As the 20^th Congress proceeds and uncertainties subside, Chinese market will likely consolidate and even stumbling higher.
• The US remains a significant overhang, and will disrupt Chinese markets.

Confidence in China and US trying to recover from lows

“Confidence is gold”, so we are told. But in today’s world of increasingly intwining markets with myriads of market participants, whose confidence is really gold? To see, we survey the underlying sentiment of various market participants.

In our last note “Saving Hong Kong” (published on 2022-10-10), we discussed how the US market sentiment appeared depressed while the actual equity positioning was still very high. As such, we concluded that the US market had not yet bottomed and would likely to continue to disturb the Chinese markets.

The epic volatility in the US market indeed persisted last week, dragging down the Hang Seng and the A-shares with it. Our call of “a trade for the brave” only eventuated on Friday. For the week, the Hang Seng was barely break even, while the A-shares fared a lot better after dipping briefly below 3,000.   

Figure 1: Chinese consumer confidence trying to recover from its worst plunge in history.

Source: Bloomberg, GROW Research

We have discussed the relationship between the Chinese and the US economy at great length in our previous notes. It is thus not surprising to find close correlation between Chinese consumer confidence and that of the US, as well as the US stocks.

On Friday, the US market was spooked by better consumer confidence reading and had a negative reversal. Yet meanwhile, Chinese consumer confidence is trying to recover from its historic plummet to its all-time low (Figure 1).

As such, although we believe that the US market has not yet bottomed due to looming recession risks, the Chinese consumer confidence indeed heralded better US confidence data last week. Unfortunately, the Fed trumps the Chinese and US confidence.

Chinese income confidence also mending

According to the latest PBoC Survey, Chinese urban depositor income confidence is also rebounding, and splitting from the S&P500. We can see that despite COVID and the subsequent damages, depositor confidence had never worsened much beyond the lowest point seen in the 2008 global financial crisis (Figure 2).

The Chinese economy struggles in 2022, and confidence has been shattered many times over. But confidence has never fallen below its all-time low and is indeed recovering. Historically, Chinese depositor income confidence had been highly correlated with the S&P 500, and at important turning points tended to lead.

We would take comfort in the fact that the Chinese urban depositors are trying to come back. Cautious as we are about the US market, we will continue to look for further improvement in Chinese depositor income confidence. It is a very slim silver lining in these dark days.          

Figure 2: China’s income confidence seems rebounding, splitting from the tumbling S&P500.

Source: Bloomberg, GROW Research

Margin traders’ risk appetite picks up.

What about the aggressive traders in the Chinese markets who trade with leverage? These are supposedly smarter and better-informed market participants. Our data analysis shows that margin trades, or leveraged bets on the Chinese market, are picking up. The turnover of margin trades as a percentage of total market turnover is rising (Figure 3). But the Chinese market is not yet responding.

Figure 3: Risk appetite in the Chinese market rejuvenating, as margin trade turnover picks up.

Source: Bloomberg, GROW Research

Note that this measure is highly correlated with the onshore Chinese market, and tends to lead by around three months. Last time when we saw such divergence between margin trades and the onshore market was around mid-2016, when the market tumbled to its lowest after the stock market bubble burst.

In the current cycle, note that the margin trading activities plummeted to a similar level as the 2016 low and then starting to bounce back. Of course, there is no guarantee that these aggressive traders would continue to bet on the market and continue their lead in the crowd. After all, this is a year when many historical norms have been broken.

But there are subtle changes in the economic fundamentals that make this recovery in margin traders’ confidence more plausible. That said, given this measure tends to lead by around three months, the last quarter of 2022 will likely see continued market volatility and consolidation. Recall that the onshore market finally bottomed out around Feb 2016, and then spent the rest of that year consolidating and struggling slightly higher.

The balance of margin trade also supports this déjà vu. The balance is still falling, hinting at margin traders are not putting in more money to work, but are probably trading more frequently instead (Figure 4).

Figure 4: But margin trade balance outstanding has not yet recovered.

Source: Bloomberg, GROW Research

Offshore CNY traders’ sentiment crushed

Another group of traders that is sensitive to changes in market conditions and economic fundamentals is the currency traders. As the offshore CNY market is in general less regulated and thus more efficient, we can read from the implied volatility in the currency options to gauge traders’ sentiment towards the CNY.

Interestingly, the implied vol in the CNH has surged to a level similar to that in Feb 2016 after the 2015 stock market bubble burst. This observation seems to be consistent with the above discussions about the margin traders’ sentiment (Figure 5).

Note that this measure is highly correlated with the on and offshore Chinese markets. Such heightened implied volatility, or depressed sentiment correspondingly, has historically been a contrarian indicator of the Chinese market – very much like the other crowd sentiment indicators that we track.

Again, there is no guarantee that volatility would not surge beyond what was witnessed during the 2015 Chinese bubble market crash. Last week, there were reports about some extreme VIX trades, with substantial bets of VIX going to 100 and 150. The highest level VIX had ever traded at so far was 89 in late 2008.

Even so, the timing of rising risk appetite among the margin traders coincides with depressed sentiment regarding the CNY. Both are auguring well for the market in the near term. These sentiment readings are also observed in tandem with better monetary stats and a re-expanding PSL.

Figure 5: CNH implied vol surging back to the level in Feb 2016. Offshore market sentiment depressed.

Source: Bloomberg, GROW Research

Conclusion

Sentiment of different market participants is on the mend: both Chinese and US consumer confidence rebounding from lows, as well as that of Chinese urban depositors.

Meanwhile, margin traders’ risk appetite perks up, and they are trading more actively. This is a prescient group of traders who tend to lead the market. Depressed CNH trader’s outlook is a contrarian bullish indicator and is supporting margin traders’ positions. All these sentiment readings are observed against a backdrop of better monetary environment.

Like 2016 after the stock bubble burst, the Chinese markets will strive to consolidate from here and struggle for higher grounds. But the US remains a significant overhang.

Appendix Figure 1: Performance of stock market sectors (annual)

Source: Bloomberg, GROW Research (Updated on 10/16/2022, same below)

Figure 2: Performance of stock market sectors (weekly)

Source: Bloomberg, GROW Research 

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English Report: 《Whose Confidence Is Gold?》

中文版报告：《谁的情绪靠谱？》