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Investors flee Chinese stocks as negativity engulfs market

Shanghai equities hit 4-year low while yuan sinks further

The Shanghai stock market has performed poorly since January, but the decline began to accelerate Oct. 8 as the gap between U.S. and Chinese interest rates narrowed.   © Reuters

SHANGHAI -- China's stock market extended the world's worst slide on Thursday, falling to the lowest in four years as the yuan neared its weakest point in a decade. With U.S. interest rates rising close to those in China, investors have begun to brace for a capital flight toward dollar-denominated assets.

The benchmark Shanghai Composite Index sank 2.9% to close at 2,486, a level last seen in November 2014.

"Selling by foreigners doesn't look like it's going to stop," said a dealer at Guodu Securities, a second-tier Chinese brokerage. On Shanghai's stock market link with Hong Kong, believed to be used mostly by investors outside China, selling of mainland shares has outpaced buying on most days this month.

Shanghai stocks have fared poorly since late January as investors fret about trade tensions and the risk of an economic slowdown. The decline gained momentum on Oct. 8, as investors returned from the weeklong National Day holiday and reacted to the U.S. Federal Reserve's interest rate increase in late September.

The yield on 10-year U.S. Treasurys has climbed to 3.2%, narrowing the spread with Chinese government bonds to less than 40 basis points -- a sharp drop from January, when the gap reached 140 basis points.

The Fed is increasingly expected to raise rates further this year, while China's central bank faces pressure to loosen monetary policy. Market watchers in China expect investors to gravitate more toward dollar-denominated assets.

Three main factors seem to be affecting the worst-performing mainland stocks. One is the trade war. The Shenzhen-listed shares of ZTE, which was temporarily banned from buying supplies from American companies, have plunged more than 50% this year. Electric car maker BYD, also listed in Shenzhen, has slumped nearly 30%.

Worries about China's slowing economic growth have made investors wary of domestic-demand-linked stocks such as condominium developer China Vanke, which has fallen 34%, and liquor producer Wuliangye Yibin, which has dropped 27%.

The yuan's weakness has hit companies with relatively high dollar debt, such as airlines. China Southern Airlines and China Eastern Airlines have tumbled 52% and 44%, respectively.

The Chinese currency softened beyond 6.94 to the dollar on Thursday, bringing it close to its lowest level since 2008. It had hovered around 6.91 to 6.92 since last week, ahead of a semiannual U.S. report on foreign exchange practices, amid speculation that China might be branded a currency manipulator.

But the Treasury Department opted not to apply that label when the report was released Wednesday. The following morning, the People's Bank of China set its daily reference rate for the yuan -- the midpoint of the day's trading band -- sharply lower.

This sparked an upswing in selling by speculators, who took this as a sign that the central bank might let the currency fall further, a source at a brokerage said.

The yuan has depreciated nearly 10% since April. A weaker currency boosts the profits of Chinese exporters, alleviating the pain inflicted by U.S. tariffs.

With trade tensions showing no signs of easing and concerns over China's economy growing, Beijing seems to be signaling that further depreciation is on the table. Prominent economist Yu Yongding, a former adviser to the PBOC, has publicly called for authorities to tolerate weakness in the currency.

The PBOC has since this summer intervened in markets to defend the yuan, with the line in the sand seen at between 6.8 and 7 to the dollar. Beijing fears a repeat of the capital flight in 2015 and 2016 that was sparked by the currency's rapid depreciation, and it is expected to ensure that any further depreciation proceeds at a gradual pace.

China is slated to release gross domestic product data for the three months through September on Friday. Though analysts generally expect authorities to affirm that the economy is still solid, they see a real stock market rally as unlikely without steps to shore up share prices.

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