Signs of deleveraging in China

Many are enamoured with the China’s super bull run in the past year or so. Naturally, signs of fatigue in the red-hot stock market will be amplified as a harbinger of a massive correction.

Source: Bloomberg

Of course, it’s hard to fault the naysayers, given that they do have rather solid evidence of a rally that could have gone too far, or at the very least, gone too far, too soon.

The 13% plunge in Chinese stock markets last week coincided with more margin trading restrictions.

The ensuing struggle between buyers and sellers that we have seen at the start of this week was to some extent papered over by good gains on Tuesday and Wednesday.

Yesterday, the buyers finally buckle, with Shanghai and Shenzhen Composites falling over 3%.

The fact that the Chinese markets were sold off as far as Greek optimism was drained on renewed signs of contention did not help. Tighter margin financing seems to have deflated the Chinese equity run as there was increasing signs of deleveraging. Margin debt fell for a fourth day on Thursday 25 June, with the outstanding margin loans on the Shanghai Stock Exchange dropping by 1%, to CNY 1.42 trillion.

The margin debt level has fallen 4% since Thursday 18 June.. In addition, Guotai Junan, China’s largest brokerage by revenue, lowered the cap single stock holding to 40% in margin trading accounts whose cash and equity value is less than 180% of borrowed asset value. The current limit is 50%, and the measure will take effect from July.

If brokerages feel the equity markets are over-leveraged which potentially makes them over-exposed, these brokers are likely to cut exposure, even if the retail traders are not too happy about it. However, I feel the PBOC would not be disappointed by this, given that a correction is healthier for the capital market in the longer term. Indigestion is clearly something the Chinese authorities want to avoid.

Therefore, moderate deleveraging should be seen as a positive development for the Chinese equity markets. It is probably not a bad idea to repeat my view that China’s leaders still view a strong capital market as beneficial for the Chinese economy, more importantly, a stable bull market is desired. Before we transit into a slow bull run, it is quite certain that we would see some crazy volatility in the transitional period. Market participants need to be aware of the large swings and hold on to the ride.

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