(Jan 31): A sell-off in Chinese stocks deepened, with a key index falling to a five-year low and wiping out all the gains that it made last week on optimism over stronger support measures by the authorities.

The CSI 300 Index of mainland shares slipped 0.9%, ending the day below its close on Jan 22 when authorities pledged more forceful measures to support the market. That was followed by expectations of a two trillion yuan (RM1.3 trillion) rescue package and the central bank’s decision to cut banks’ reserve requirement ratio.

The benchmark gauge tumbled 6.3% in January, a record sixth straight month of losses, amid fears the authorities are still not doing enough to counter a deteriorating economic outlook and multi-year property crisis. A Hong Kong court’s decision this week to liquidate China Evergrande Group and jitters over losses linked to so-called snowball derivatives as well as structured derivatives in Hong Kong added to the slump.

“Investor sentiment is still extremely bearish on China — any minor rally driven by piecemeal news of government support is likely to be met by more selling,” said Vey-Sern Ling, managing director at Union Bancaire Privee in Singapore. “It’s not clear whether China’s structural issues can be resolved and how determined the leadership is in prioritizing growth.”

China’s economic outlook appears to be worsening, with data on Wednesday showing a gauge of factory activity contracted for a fourth month in January. Some US$6 trillion has been wiped off the market value of Chinese and Hong Kong stocks since a peak reached in 2021 and investors are demanding that authorities deploy bolder measures to arrest the downturn.

Sentiment was boosted last week on news about a potential rescue package which would mobilise funds mainly from the offshore accounts of Chinese state-owned enterprises to buy shares through the Hong Kong exchange link. The Hang Seng China Enterprises Index, that tracks mainland companies listed in Hong Kong, jumped 9% over three days before running out of steam.

There are signs some state-led funds are buying in an effort to help support share prices. A handful of Chinese exchange-traded funds seen by traders as likely purchase targets by state vehicles such as Central Huijin Investment Ltd. have seen record inflows this month. Their combined inflows were more than five times the aggregate amount seen in July 2015, when the so-called “national team” jumped in to stem a rout.

The fact that share prices have unraveled last week’s gains though shows just how pessimistic many investors are. The CSI 300 closed Wednesday at its lowest level since January 2019, while overseas investors extended their dumping of China onshore stocks to a sixth month.

“Despite recent measures by Chinese authorities to support growth and markets — including fresh cuts to banks’ reserve requirements — we retain our cautious strategic view on Chinese assets,” Homin Lee, senior macro strategist at Lombard Odier, wrote in a client note. The market pessimism “is unlikely to change for the foreseeable future even if intermittent ‘market rescues’ produce short-term bounces.”

Chinese stocks’ brutal start to the year is being at least partly blamed on the impact of a relatively new financial derivative known as a snowball. The products are tied to indexes, and a key feature is that when the gauges fall below built-in levels, brokerages will sell their related futures positions.

While there isn’t any single level that analysts agree as a major trigger for knock-ins, China International Capital Corp in October estimated the levels where most investors would lose coupons would be 4,865 points on the CSI 500 Index, a level that has already been breached.

At the same time, retail traders in Hong Kong saw banks call in US$1.55 billion of leveraged derivatives during the recent stock slump, exacerbating volatility and highlighting the risk of the popular structured product.