By Chelsey Dulaney and Steven Russolillo 

Investors are piling into bets against China's stocks and currency, reviving what has been one of Wall Street's most popular -- and painful -- trades in recent years.

Asset managers including Invesco Ltd. have amassed positions that will pay off if the Chinese yuan continues to slide, while investment firms like Muddy Waters Research and Blue Orca Capital LLC have announced new bets against Chinese stocks.

Rising interest in shorting, or betting against, Chinese markets comes amid an intensifying trade spat with the U.S. that investors fear will exacerbate the country's economic slowdown.

"If you get the next round of tariffs, it's going to deliver a larger economic shock than what you witnessed in Asia in 2015 and 2016," said James Ong, a senior macro strategist at Invesco who is betting against the Chinese currency. "It might challenge their control of the currency to a greater degree."

On Friday, China said it would impose levies on $60 billion of U.S. goods if Washington moves forward with plans to more than double its tariffs on Chinese imports.

Trade fears have already rocked Chinese markets in recent months. The yuan has tumbled around 5% against the U.S. dollar this year, while the Shanghai Composite Index is down 17%. Investors have made roughly $7.1 billion betting against Chinese and Hong Kong companies, according to Ihor Dusaniwsky, head of predictive analytics at S3 Partners.

That comes after a dismal 2017 performance for short-selling investors, many of whom were caught off guard by last year's global market rally. The Shanghai Composite and yuan jumped 7% against the dollar, while Hong Kong's Hang Seng Index surged 36%. That sent short sellers to a roughly $35 billion loss in 2017, according to S3.

Kevin Smith, founder of Denver-based asset manager Crescat Capital, was one of them. His firm's global macro hedge fund declined 23% last year, the worst return in its 12-year history, thanks to bets against Chinese stocks and the yuan.

The dismal performance led to the departure of two of the firm's largest clients and brought its assets under management down to $46 million from a peak of $94 million in 2016. This year's market reversal has helped the fund recover 14% through June.

"From everything we can see, it's happening now," said Mr. Smith. "The currency is declining; the equity markets are in a bear market. I think this is going to be one of our best years ever."

U.S. investors have long sought to profit by shorting Chinese markets. Carson Block, founder of San Francisco-based Muddy Waters and a subject of the 2017 documentary The China Hustle, rose to fame in 2011 after he revealed fraudulent practices at Chinese forestry company Sino-Forest Corp. The company filed for bankruptcy the following year.

His latest target is TAL Education Group, an after-school tutoring firm in China he claims is "a real business with fake financials" and has likened to the 2001 Enron accounting scandal. The company's U.S.-listed shares had risen over 50% this year through June 12 before he unveiled his bearish thesis on the company. Since then, the stock has dropped around 30%. A TAL spokesperson didn't immediately respond to a request for comment.

Soren Aandahl, who runs Texas activist investment fund Blue Orca Capital LLC, last Tuesday unveiled his latest short bet: GDS Holdings Ltd., a provider of data-center infrastructure and services in China. Mr. Aandahl criticized the company's "staggering debt burden" and raised concerns about the company's ability to repay dollar-denominated debts amid the yuan's slide. GDS's U.S.-listed shares tumbled 37% the day the report was published. The company said in a statement that Blue Orca's claims are "false" and "reflect a fundamental misunderstanding" of its business.

Other investors are betting on broader declines in China's markets. Short sellers have added roughly $300 million in bets against the iShares China Large-Cap ETF this year, according to S3 Partners. They've also raised short bets on Chinese companies trading in Hong Kong that would likely be harmed by a slowdown in growth, such as property developer China Evergrande Group and cement manufacturer Anhui Conch Cement Co.

Paresh Upadhyaya, a portfolio manager at Amundi Pioneer, had long avoided betting against the yuan due to the cost of shorting the currency. A few weeks ago, he began shorting the yuan in offshore markets for the first time "in recent memory."

"The real wild card is these trade tensions and how much further do they escalate," Mr. Upadhyaya said.

Many investors have struggled to turn a profit on bearish China bets in the past. That's in part because some underestimated China's ability to stabilize its economy and financial markets, analysts say. Beijing maintains tight control over the value of the yuan, liquidity in the financial system and the ease of taking money offshore -- all tools China tapped to help control the fallout of its 2015 currency devaluation.

"People have gotten China very wrong before," said Mr. Aandahl. "There's a classic quote in short selling: It's not enough to be right; you have to be right, now."

The Chinese government has also struck back at short sellers in the past, launching investigations into some investors and squeezing others out of positions by driving up the cost of borrowing in Hong Kong, where many investors short Chinese assets due to fewer restrictions.

Beijing revived efforts to deter short sellers on Friday by announcing it will impose a 20% deposit requirement for trading currency forwards, effectively making it more expensive to bet against the yuan.

China's efforts to control market reactions have driven many bearish investors out of the market and left others hesitant.

Hayman Capital's Kyle Bass scaled back his China position after the fund posted its worst-ever annual return in 2017, he told The Wall Street Journal earlier this year. Mr. Bass didn't respond to requests for comment. Longtime China bear Jim Chanos has also scaled back his bets against China, saying in an email: "Given the eight years of underperformance of the Chinese market, we are less short China now than in the past."

Write to Chelsey Dulaney at Chelsey.Dulaney@wsj.com and Steven Russolillo at steven.russolillo@wsj.com

(END) Dow Jones Newswires

August 04, 2018 12:14 ET (16:14 GMT)

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