China small-cap stocks boosted by state rescue package as 220 million individual investors gain confidence in outlook

Expectations about further policy loosening set off a frenzy on liquidity-sensitive small-caps, and a lull in the release of economic data has investors placing event-driven thematic investments in stocks linked to artificial intelligence (AI) and humanoid robots, according to Fu Jingtao, a strategist at Shenwan Hongyuan Group in Shanghai.

“Thematic trades have been pretty active, and that is fuelling the breeding ground for small-caps,” he said. “Given the wealth effect from the sector, the moment on small-caps has yet to run its course.”

The recent slide in government-bond yields may reinforce investors’ bets on smaller companies, whose returns typically move inversely with debt yields. The 10-year sovereign bond currently yields 2.36 per cent, close to an 18-year low of 2.353 per cent in February on mounting expectations about a further reduction in borrowing costs.

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Some investors remain cautious about the outperformance of smaller companies, citing their disadvantages versus large companies in valuations and profitability. Small-cap stocks will probably face headwinds as increased new listings diminish their value as potential targets for reverse mergers and the regulator cracks down on manipulation and continues efforts to delist unqualified companies, according to Li Bei, founder of hedge-fund firm Shanghai Banxia Investment Center.

The preference for smaller companies in mainland China diverges from the global trade pattern. In the US, small-caps have been in the doldrums, massively underperforming the “Magnificent Seven”, including Nvidia and Amazon, which offer exposure to the booming AI business.

The strong performance of China’s small-caps compared with larger companies stretches over the past three years. The CSI 500 dropped 7.4 per cent last year and the CSI 1000 lost 6.3 per cent, while the CSI 300 slid 11 per cent. In 2021 the two small-cap gauges rose at least 15 per cent against a 5.2 per cent loss for the CSI 300.

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Small-cap companies tend to post faster earnings growth when the economic outlook improves, while mature ones see slower growth rates.

“Thematic trades simply mean that the run in small-caps is in the very early stage,” said Wang Yang, an analyst at Zheshang Securities. “For the rally to sustain, you’ll need to see significant growth in earnings and an uptick in the economic cycle.”