Hedge funds are playing a dangerous game on Japan and China

Both Japan and China may be going through a structural break, in that what happened in the past no longer offers a window into the future. For now, macro trading doesn’t work, at least not in these two important markets.

For years, investors were conditioned to brush away a run-up in Japanese stocks as another flash in the pan, while salivating at any rumour of stimulus measures from Beijing. After all, they were guided by trial and tribulation. In 2013, foreigners poured in about $155 billion, wholeheartedly embracing Abenomics. That euphoria evaporated as investors became disillusioned with a perpetual wait for structural reforms and for the Bank of Japan to hit its 2 percent inflation target.

Meanwhile, Beijing has an enviable history of shock and awe. The shantytown redevelopment, a poverty alleviation program that replaced older, rundown dwellings with new, affordable housing, pulled China’s market out of a 2015 slump. The government’s decisive and effective Covid controls in the early days of the pandemic kept the economy going, while much of the world was in chaos.

These historical lessons perhaps guided Chua and his strong convictions, even as many money managers were going the other way. “The Nikkei-Hang Seng spread has moved from -16,000 to +16,000 over the past decade, back to levels before China joined the WTO,” he wrote in the closure letter, referring to the relative outperformance of Japanese stocks.

Chua was burned by the strength of hot money flows into Japan and too much faith in Beijing’s policymakers. In the letter, he marveled that Nikkei ETFs were bought at a 20 percent premium to their net asset value in mainland China, and said he underestimated “how long this will continue.” Meanwhile, “inconsistent market support from China resulted in the persistent and substantial down move in the Hang Sang Index.”

To be sure, the possible structural changes may just be a mirage, and Japan and China will go back to their old ways. Hot money is fickle, while the Japanese may still stay away from their home market even with the arrival of tax-free investment accounts. At the same time, China’s stock market rout has become a political problem that may ultimately force Beijing’s hand. Chua’s vision may ultimately be proven right.

This year, everyone loves Japan and hates China. But don’t construct a long-short trade either way. Macro funds work well when there are clear trends, such as the unstoppable dollar rally in 2022. As the BOJ and President Xi Jinping keep markets in the dark, one can be caught out by either side. “I have lost my knowledge, trading and psychological edge,” conceded Chua. Let that veteran’s words be a warning to those who are still in the game.

Shuli Ren is a Bloomberg Opinion columnist. Views do not represent the stand of this publication. 

Credit: Bloomberg