Beware the falling knife: China’s turn to tyranny has sent investors fleeing

There’s nothing quite like a bear market for testing stock adages to destruction. This week’s piece of conventional wisdom under the spotlight was “don’t catch a falling knife”, as the Hang Seng index went into freefall at the close of China’s 20th Communist Party Congress.

The drop in Hong Kong’s benchmark equity index – nearly 10 per cent at one point on Monday, its worst one-day fall since the financial crisis in 2008 – reflected unease, in particular among overseas investors, about what President Xi Jinping’s consolidation of power would mean for the world’s second-biggest economy and its financial markets. The general consensus is that Xi’s dominance, underpinned by a uniformly loyal politburo standing committee, means a continuation of the recent focus on social stability and so-called common prosperity at the expense of economic growth.

The market reaction reflects dashed hopes for a more pragmatic approach, in particular with regard to the ongoing zero-COVID policy which contributed to GDP falling well below Beijing’s 5.5 per cent annual target in the latest quarter. The published number – 3.9 per cent – was held back until after the Congress closed for reasons that are obvious in light of the market response.

The fallout from the Congress was not limited to stock markets in Shanghai, Shenzhen and Hong Kong. In New York, Nasdaq’s Golden Dragon index of US-listed Chinese shares dropped by more than 14 per cent on Monday, its largest ever one-day fall. Its decline so far this year is now 50 per cent.

The “falling knife” expression was coined for precisely this kind of air pocket. Its derivation hardly needs explaining. When a sharp kitchen knife slides off the counter, everyone knows the messy consequences of trying to grab it in mid-air.

The difference between the culinary and investment contexts, however, is that for a market trader a falling knife can, in certain circumstances, provide one of those rare money-for-nothing moments when a drastic overreaction by the market is quickly reversed. This is rarely the case in the kitchen.

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A good recent example of this was the gilt market rout in the wake of Kwasi Kwarteng’s ill-fated mini-Budget. Between March and September, the price of the 30-year UK government bond halved, as first interest rates rose and then investors took fright at the Government’s unfunded tax cuts. The final 10 days of market dysfunction saw the price fall by 20 per cent but in the past week and a half, it has recouped all of that fall, a 25 per cent rebound in a matter of days. A complete round trip in three weeks. It has been the trading equivalent of a perfectly judged grab of the handle. A bloodless coup.

To have achieved that would have required two things. First, the ability to see the opportunity. This is actually the easy bit. I would point somewhat shamelessly to my last two columns in which I flagged up the unfolding opportunity in fixed income. The second part is much harder, actually acting on the insight. I didn’t by the way, which rather illustrates the point. I have once again been reminded of my old friend Jim Slater’s quip: “Yes, but I actually did it.”