Market players remained cautious, however, with early gains on the Shanghai Composite Index fading, while turnover in Hong Kong did not show a sharp pick up to accompany the rally, suggesting gains in banks were still coming from short-covering rather than buying by long-only funds.
The Shanghai Composite ended the morning up 0.72 percent at 2,361.58 after opening up 2.4 percent. In Hong Kong, the Hang Seng Index was up 3.26 percent by the midday trading break.
The sharpest move came on the China Enterprises Index of top Hong Kong-listed Chinese companies, which rose 5.55 percent.
Central Huijin Investment Co, the domestic investment arm of China’s sovereign wealth fund on Monday started adding to its controlling stakes in the top state lenders, the first explicit signal that the government is seeking to prop up a market that has struggled for the last two years.
The move spurred a rush to cover short positions on Chinese banks late on Monday and carried over to Tuesday, lifting stocks across the sector and adding a combined $56.6 billion to the market value of the Hong Kong listings of the top four banks.
“It is to send a signal, and apparently investors are responding to the signal,” said Jim Antos, Chinese banking analyst with Mizuho Securities. “Even if it’s the H-shares, foreign investors are responding to the signal, or at least it’s all the people who were betting against these Chinese banks, so they’ve decided, ‘Oh, maybe that’s a little too risky to do, so let’s close our short positions’.”
Banks, among the most liquid stocks in Hong Kong, have become one of the most popular ways for investors bearish on China or for those looking for a relatively cheap way to hedge long China portfolios.
Short-selling as a percentage of overall turnover dropped off on Monday following the move with China Construction Bank Corp. seeing only 6.3 percent of turnover shorted compared with 15 percent in the previous month.
Worries over the quality of loan books, a clampdown on off-balance sheet lending and a weakening of the mainland property market, which could mean write-downs for banks, has pushed valuations for banks to near or below historic troughs.
Over the past year, Chinese banks have seen valuations continue to tread lower with investors caught on the wrong side of the trade at least twice this year.
Industrial & Commercial Bank of China Ltd. currently trades at a price-to-book multiple of 1.5 and a forward 12-month price-to-earnings multiple of six times, according to Thomson Reuters Starmine. On both counts, they are the lowest valuation at which the stocks have traded.
However, the battle between those who see Chinese banks as undervalued and those betting on further underperformance is unlikely to be over.
While Huijin’s move helped sentiment, much more would be needed to turn around a market that has fallen about 30 percent since the start of 2010 under the weight of government efforts to rein in inflation and uncertainty in global markets, analysts said.
Tuesday’s reaction was much more subdued than after a similar move three years ago.
The day after Huijin initially announced similar share purchases in September 2008, the Shanghai index rose 9.5 percent, but fell back in following weeks as worries the financial crisis could linger came to the fore.
“This is psychological more than anything fundamental. If 2008 offers any indication, we could see stock prices dip after an initial boost,” said Cheng Yi, senior analyst at Xiangcai Securities in Shanghai. “For a reversal of trend, monetary policy probably needs to loosen and investors need to be assured of the basis of its earnings growth.”
Some analysts said the government could follow up with additional steps to support the stock market, such as slowing the approval of new listings, but investors still faced murky waters.
“It’s too early to say the market has bottomed out, with uncertainties surrounding major global economies including the United States and European nations,” said Zheng Weigang, senior trader at Shanghai Securities. “Investors are also jittery over the impact of an expected weakening in China’s property market in coming months.”
