Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67% of retail investor accounts lose money when spread betting and/or trading CFDs with this provider. You should consider whether you understand how spread bets, CFDs, OTC options or any of our other products work and whether you can afford to take the high risk of losing your money.

China big techs stocks mean reversion rebound occurred. What’s next?

We have highlighted a couple of weeks ago that that the recent sell-off seen in China big tech stocks such as Tencent, Alibaba, Tencent, JD.com, Baidu, NetEase have reached to a point of intense fear and panic due to the “never ending”  rounds of regulatory measures targeted at these Chinese tech juggernauts initially that have also spread to the rest of the wider China economy. The odds of at least a mean reversion rebound have increased for these battered down China big tech stocks that declined by close to -50% from their recent February peak and drawdown of around $1 trillion in combined market capitalisation.

The KraneShares CSI China Internet ETF (KWEB) that consists of a basket China big tech stocks listed on the US stock exchange has managed to stage an accumulated rally of +16% from its 19 August low to Tuesday, 24 August close of 50.45. (see chart 1)

Chart 1- Performance of KraneShares CSI China Internet ETF against US Big Tech

Source: TradingView (click to enlarge chart) 

The 4-week Rate of Change of the ratio of KWEB/US Big Tech has reached an all-time low on the week of 26 July 2021 and posted a bullish divergence thereafter which increases the odds of a mean reversion rebound in KWEB.

As more measures or clampdowns are being announced from official channels or opinionated on state-owned media and think tanks, these regulatory reforms seems to be getting a more “nationalistic” blend instead of best business practices where these reforms seem to  form a corner stone of China President Xi’s “common prosperity” social initiative to spread the wealth obtained from the private sector to the man in the streets with the aim of closing the inequality gap.

Interestingly, the timing on the implementation of such socialist measures coincided on the backdrop of President Xi’s bid for an unprecedented third presidential term in the once in five year Chinese Communist Party leadership reshuffle to be held at the 20th National Party Congress in October 2022.

With the first leg of the mean reversion rebound in motion what are the next macro driver we need to pay attention other than the usual regulatory landscape.

Firstly, the inverse of USD/CNH (offshore yuan) has been displaying a high direct lock step movement with the KraneShares CSI China Internet ETF (KWEB) in general since late December 2016 with some occasional correlation breakdown in several shorter periods in between. Thus, on the average if the offshore yuan appreciates against the US dollar, China big tech stocks as represented by KWEB will tend to have similar upside movement and vice versus when the offshore yuan depreciates against the US dollar.

In the recent period from May to June, the longer-term average positive correlation between CNH/USD (inverse of USD/CNH) and KWEB flipped to a negative reading to as low as -0.81. In the last four weeks, their correlation has managed to revert to its longer-term lock step behaviour with a positive correlation of 0.60. (see chart 2) This implies that the movement in the offshore yuan can be a factor that drives the potential returns of KWEB. From a causation reasoning, an appreciating yuan against the US dollar can led to a higher total return for international investors when returns obtained from Chinese stocks are converted back to the home currency, for example the US dollar.

If such behaviour persists, it tends to trigger more foreign capital inflows into China financial assets such as bonds and stocks which in turn create a positive feedback loop back into China big tech stocks.

Chart 2- Correlation between KraneShares CSI China Internet ETF & Chinese yuan

Source: TradingView (click to enlarge chart)

Secondly, let’s us now examine what are possible drivers that can impact the movement of USD/CNH. If we do a relative performance of the US Dollar Index, a weighted measurement of broad USD performance against the EUR, GBP, CHF, CAD, JPY and SEK against the USD/CNH over a period from 31 May 2021(the most recent medium-term swing low of USD/CNH) to 24 August 2021, the US Dollar Index has rallied by +3.6% versus a gain of +1.8% seen in the USD/CNH which suggests that the recent USD appreciation against the offshore yuan is lesser in terms of magnitude by around two times. Hence, we are seeing a rather stable Chinese yuan despite the current year to date stark underperformance of China stocks against US stocks in general. One of the key factor to prevent further potential upside in the USD/CNH seems to be yield spread between the US 10-year Treasury and the China 10-year sovereign bond, the spread has widened by 106 basis points from November 2020 to May 2021 before it stalled at a significance resistance of -1.45% to hover around a tight range of around 24 basis points in the last three months. (see chart 3)

Chart 2- USD/CNH with 10-Year US Treasury-China Sovereign Bond yield spread

Source: TradingView (click to enlarge chart)

In the prior narrowing of the US Treasury-China sovereign bond yield spread that kickstarted earlier on February 2020 led to a significant decline of -11% (yuan appreciation) on the USD/CNH from its May 2020 all-time high of 7.1964 to a low of 6.3526 printed on May 2021. In addition, the recent widening of the yield spread that started on November 2020 preceded the recent rebound of +1.8% (yuan depreciation) seen in the USD/CNH from its May 2021 low.

Given its latest positive correlation reading of 0.60 between the USD/CNH and KWEB (China big tech stocks), a narrowing of the US Treasury-China sovereign bond yield spread in the near to medium-term may led to another round of Chinese yuan appreciation (a decline in USD/CNH) which in turn could provide a potential catalyst for the second leg of the mean reversion rebound in China big tech stocks.

Background image

Find your flow: four principles for trading in the zone

Learn about the four trading principles of preparation, psychology, strategy, and intuition, and gain key trading insights from some of the world's top investors.

Get this free report
Mobile trading app


Disclaimer: CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.