Chinese stocks are trying to rebound. This is the trade to watch to know if the turnaround is for real

Published Sun, Feb 11 20244:53 PM EST

Evelyn Cheng @in/evelyn-cheng-53b23624 @chengevelyn

Mainland Chinese stocks are trying to rebound from five-year lows and it's starting to look like Beijing is willing to take some action. At least, that's the view of Clocktower Group's Chief Strategist Marko Papic. He told me on last week he thinks Chinese stocks could see a short-term rally of 10% or more in coming days, based on a Bloomberg report of Chinese President Xi Jinping potentially meeting with financial regulators. But what Papic is watching in the markets is a move higher in Chinese government bond yields. "One of the best trades for Chinese assets has been to be long bonds, best performing in the world," Papic said. "My question is, would a recovery in [the] Chinese economy and the stock market be the end to that multi-year rally in Chinese bonds?" he said. "Something to think about for global bond investors. When yields start going up, you will know [it's a] bottom [in the] economy." Bond prices fall when yields rise and vice versa. The Chinese 10-year government bond yield has traded around 2.6% versus just over 4% for its U.S. counterpart, according to Wind Information. If Chinese bond yields started to climb, that would likely indicate investors were rotating out, Papic pointed out. It's not clear whether those investors are ready to buy stocks yet. The Shanghai composite closed more than 1% higher Thursday, helping the index recoup some of its losses for 2014 on the final day of trading before the Lunar New Year holiday. Mainland Chinese stock markets are closed and don't re-open until Monday, Feb. 19. "Recent measures from China to support the stock market are welcoming and should likely stabilise markets, but for a sustained relief rally, we think China will need to address the core of investor concerns i.e. property sector/economy and U.S.-China relations," Nomura research analysts said in a note Wednesday. They expect if sentiment remains weak, foreign capital still has scope to sell out of mainland Chinese and Hong Kong stocks. Consumer price data out Thursday was not encouraging as it showed yet another month of weak demand, including in sectors such as travel. Thursday's stock market gains also followed news that Beijing late the prior day announced it dismissed Yi Huiman as head of the securities regulator and replaced him with Wu Qing, who once oversaw the Shanghai Stock Exchange. To Eurasia Group, such a change was a predictable result of Xi's high-level involvement. The analysts said that earlier this year, Chinese officials had started to lay out a strategy for guiding domestic investment into stocks, and had previously acknowledged to the consulting firm that it would "require a change in both the macro environment and the profitability of listed firms." "But by January, many of these same contacts were rolling their eyes over the leadership's continued focus on propaganda, security, and administrative controls instead," Eurasia Group analysts said in a report. "These policy signals reinforce Eurasia Group's expectation of a continued incremental approach to economic and growth policy and the preference for tighter regulation of financial activities." The ongoing debate will continue in markets after China returns from a week-long break, its biggest holiday of the year. The Hong Kong stock exchange is only closed Feb. 12 and 13 for the holiday. "For now, after short-term liquidity risks are mitigated, investors may refocus on inflation/housing market trends this year, watch for earnings pickups and analyse macro policy signals," UBS equity strategists said in a report Wednesday. Their top mainland Chinese A share picks, by greatest expected upside, are solar power supplier Sungrow and semiconductor equipment maker Naura Technology, both listed in Shenzhen, and Shanghai-listed Tuopu, an auto parts supplier to Tesla. The UBS analysts expect shares of Sungrow can more than double from Tuesday's levels, while those of Tuopu can climb by 90% and Naura Technology can see gains of more than 50%. — CNBC's Michael Bloom contributed to this report.