Chinese government leaves stock market to its own devices?

It has been a day of record declines in Asia. Most spectacular were all of the China indexes plummeting through all key support levels.

China
Source: Bloomberg

The CSI 300 went limit down at one point, with trading halted after it fell over 9%. The Shanghai Composite (SHCOMP) dropped straight through the key 3500 support level, falling 8.5% – almost to the 3200 level, before beginning to find somewhat of a base.

Global markets look set to continue their rout into the European and US sessions. And yet the current global economic environment does not seem to warrant such a dramatic sell-off. Volumes in global markets are famously thin in August, possibly leading to these outsized moves. Investors will be looking to major news announcements this week that may change sentiment in global markets and provide a floor to these downward moves. Thursday will see the release of US GDP and PCE inflation data, the beginning of the Jackson Hole Symposium, and the release of Japanese CPI data. Although if markets continue to decline at this rate until then, we could be seeing the biggest global correction since 2009.

After the SHCOMP fell 11.5% last week, there were growing expectations for the People’s Bank of China (PBoC) to inject liquidity or cut the reserve requirement ratio (RRR) over the weekend. Earlier in the day, Chinese markets were looking like they may have a better day compared to Japan and Australia. The weekend announcement that Chinese pension funds would invest 30% of their capital in the domestic equity markets, and the expectation for the authorities to step in at the 3500 level arguably made a case for the index to gain. However, as soon as the China futures markets opened, prices started moving down dramatically. Any close below 3233 would wipe out the entire gain for the year for the SHCOMP. A disastrous result for China, after working so hard to breathe life back into domestic equities after the 2007 crash and having spent hundreds of billions of dollars propping up the market since June.

It is a key moment for China. The equity market in free fall, the banking system increasingly starved of liquidity, rising capital outflows, and a rapidly slowing economy. The annual meeting of the top leadership at Beidaihe has ended (one of the reasons Li Keqiang was delayed in visiting Tianjin), and no doubt there were very serious discussions over how the 7% growth target is going to be met. That target is now looking overly ambitious, and the most sensible way forward would seemingly involve further currency devaluation, further RRR cuts, and stepped up fiscal stimulus.

One of the main issues for China is managing its debt. Xi Jinping’s tenure has been associated with a significantly increased push for financial and economic reform, largely driven by key personnel such as Lou Jiwei in the Ministry of Finance, Zhou Xiaochuan in the PBoC, and Liu He as one of Xi Jinping’s main economic advisors. Pivotal in the pursuit of stabilising the Chinese economy is dealing with the huge amount of local government debt generated during the 2009 stimulus package and held by local government financing vehicles (LGFVs). Lou Jiwei has spear-headed the push to move this off-balance sheet LGFV debt onto the balance sheet through provincial government bond issuance.

However, local banks were reportedly reluctant to buy the debt at their low yields, but the government forced them to. This is another major reason why banks have been reluctant to issue new credit, and possibly a significant reason why the fiscal stimulus taps have been operating at a mere drip.

Today’s action in the Chinese equity market is surely going to prompt some major moves by the government.

Japan

Toyota has been one of the biggest movers on the Nikkei, losing as much as 5.3% after they announced a two-week shutdown of their facilities near the Tianjin blast site. The financial sector saw the biggest decline on the index, down 5.5%, with six other sectors all falling more than 4%.

The JPY has been surging as a perceived global safe haven, severely damaging Japan’s hard won export competitiveness. The JPY has strengthened 2.5% against the USD over the past three sessions, with far larger moves against Asian competitors.

The ASX

The ASX is now at its lowest level since August 2013 after losing 3.3% today. Energy, materials and financials saw the biggest sectoral declines. Energy stocks were down 5.3%, and materials and financials were down 3.8% and 3.5% respectively.

Only 16% of companies are above their 50-day moving average. In the past, any level below 20% has been a key indication of over-selling, with the index usually recovering quite rapidly afterwards. There are not any strong macro reasons for a rally yet; however, it is important to keep an eye on this as a lot of stocks are seeing their values become increasingly competitive.

The main factor for Australia, as with most global markets, will be moves out of China. A significant RRR cut (ie 100 basis points or more), along with stepped up fiscal stimulus, would likely halt the decline in the ASX.

Fortescue (FMG) released their earnings well below estimates today. Net income declined 88% from a year earlier due to the crash in iron ore prices, coming in at $317 million below estimates for $417 million. After seeing the stock rally on the back of rising iron ore prices and speculation that it may sell off some of its assets to a Chinese group, the stock has crashed today, falling 12.5%.

Bluescope (BSL) was one of the bright spots in the ASX. It had a solid earnings report, with EBIT 9% of estimates at $302 million. This was driven by strong growth from Australian Steel Products and Global Building Solutions, which helped offset the decline in NZ Steel. Bluescope asked for the government’s assistance in helping it meet its requirements for $200 million of savings in Australia and $50 million in New Zealand. It said if it could not increase its competitiveness, it may be forced to shut its Australian and New Zealand upstream operations, and simply import hot rolled coil and billet for its downstream operations.

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