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Foreign investors are selling Shanghai shares at a record pace as China steps up government intervention to combat a stock-market rout that many analysts say was inevitable.

Sales of mainland shares through the Shanghai-Hong Kong exchange link swelled to an all-time high on Monday, while dual-listed shares in Hong Kong fell by the most since at least 2006 versus mainland counterparts. Options traders in the U.S. are paying near-record prices for insurance against further losses after Chinese stocks on American bourses posted their biggest one-day plunge since 2011.

The latest attempts to stem the country’s $3.2 trillion equity rout, including stock purchases by state-run financial firms and a halt to initial public offerings, have undermined government pledges to move to a more market-based economy, according to Aberdeen Asset Management. They also risk eroding confidence in policy makers’ ability to manage the financial system if the rout in stocks continues, said BMI Research, a unit of Fitch.

“It’s coming to a point where you’re covering one bad policy with another,” said Tai Hui, the Hong Kong-based chief Asia market strategist at JPMorgan Asset Management, which oversees about $1.7 trillion. “A lot of investors are still concerned about another correction.”

Bubble Warnings

Strategists at BlackRock Inc., Credit Suisse Group AG, Bank of America Corp. and Morgan Stanley last month warned the nation’s equities were in a bubble. When the Shanghai Composite reached its high on June 12, shares were almost twice as expensive as they were when the gauge peaked in October 2007 and more than three times pricier than any of the world’s top 10 markets, on a median estimated earnings basis.

A 29 percent plunge by the gauge through Friday, the steepest three-week rout since 1992, prompted a flurry of measures to stabilize the market. A group of 21 brokerages pledged Saturday to invest at least 120 billion yuan ($19.3 billion) in a stock-market fund, executives from 25 mutual funds vowed to buy shares and hold them for at least a year, while Central Huijin Investment Ltd., a unit of China’s sovereign wealth fund, said it was buying exchange-traded funds.

“The more resources authorities commit to propping up the stock market, the more they ratchet up the potential fall-out risks should the market continue to collapse,” said Andrew Wood, an analyst at BMI Research. “This could give rise to a crisis of confidence in the authorities’ ability to support both the stock market and the real economy.”

China Stock Valuations No Longer That Stretched: Jolley

Valuation Gaps

While the efforts spurred a 2.4 percent rally in the Shanghai index Monday, largely due to gains by the nation’s biggest firms, they failed to convince investors outside the mainland. Overseas investors were net sellers of 13.4 billion yuan of mainland shares through the Hong Kong link on Monday, the most since the program began in November.

A Hang Seng index tracking the mainland premium on dual-listed shares surged 10 percent Monday, the most since the data began, as shares in Hong Kong plunged. The MSCI China Index sank

4.1 percent and the Bloomberg China-US Equity Index retreated

5.1 percent.

Shares of PetroChina Co., the nation’s largest company by market value, fell 1.9 percent in Hong Kong Monday, even as they jumped by the daily limit of 10 percent on the mainland amid speculation of buying by state-directed funds. The divergence meant the company’s Hong Kong shares were 48 percent cheaper than their yuan-denominated peers, the biggest discount in six years.

Underweight Stocks

“It’s coming to a point where you’re covering one bad policy with another”

“The A-share market is now trading well beyond common sense,” said Sam Le Cornu, Hong Kong-based co-head of Asian listed equities at Macquarie Investment Management, which oversees about $264 billion globally. The government’s support measures have “done little to stabilize and a lot to spook,” he said.

Le Cornu said his Asian New Stars fund is now “significantly” underweight China after being overweight for seven years.

The Shanghai Composite dropped 1.3 percent at the close Tuesday, with 16 stocks falling for each that rose. The Hang Seng China Enterprises Index of mainland shares traded in Hong Kong slid 3.3 percent, entering a bear market after tumbling more than 20 percent from its recent high. Foreign investors sold a net 10.3 billion yuan of mainland shares via the link Tuesday.

Even after the slump, the median valuation of stocks on the Shanghai and Shenzhen exchanges amounts to 59 times reported earnings, almost triple the Standard & Poor’s 500 Index.

“It’s too soon to say that the correction is over,” Tim Schroeders, a portfolio manager who helps oversee about $1 billion in equities at Pengana Capital Ltd. in Melbourne, said by phone. “Investors are increasingly concerned about high valuations and are focusing on risk mitigation.”

ETF Bets

Traders in the largest U.S. exchange traded fund tracking mainland shares are bracing for more losses.

Short-interest in Deutsche Bank AG’s $859 million ETF rose to a record 23 percent of shares outstanding on July 1, data compiled by Bloomberg and Markit Group Ltd. show.

The cost of options protecting against a 10 percent drop in the ETF was 11.5 points more than calls betting on a 10 percent increase on Monday, according to three-month data compiled by Bloomberg. The price relationship known as skew climbed to 11.8 points last week, the highest since the ETF started in November

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For Aberdeen Asset Management’s Nicholas Yeo, China needs to let fundamentals govern its stock market, not state directives.

“International investors are skeptical that all the government measures are short-term, cosmetic,” said Yeo, the Hong Kong-based head of Chinese equities at Aberdeen Asset, which oversees about $491 billion worldwide. “If you want it to be a proper market, there should be less interference.”

(For more on Chinese stocks, click here.)