China stocks crumble

Just when we thought that perhaps the Chinese authorities have the ability to defend the equity markets, the market proved us wrong.

Source: Bloomberg

It’s now widely reported that the Shanghai market suffered its largest one-day fall at 8.5% in eight years.

The primary driver for the plunge was due to fears of a quick withdrawal of the support measures which have been in place for about three weeks now. This came on the back of the IMF’s cajoling for China to allow market forces to sort things out in the longer term. Reuters also noted that there was talk about the China Securities Finance Corp paying back loans it had taken to stabilise the stock market earlier than scheduled. Despite the government vehemently denying the rumours, investors are not entirely convinced. The distrust may stem from the fact that the government has deployed a heavy-handed approach to shore up the domestic stock markets. What’s more poignant was that the authorities were still rather sanguine near the beginning of the stock slump in mid-June, saying that the correction is necessary for a healthy stock market. They did an about turn soon after and came up with harsh measures, including an outright ban on short selling for certain investors and permitting over half of A-shares to suspend trading, in a bid to stave off the selling.

A recent bunch of weak macro data also added worries that we could see further weakness in the Chinese economy. The much lower-than-expected flash PMI reading was certainly a huge surprise for the market. Industrial profits also fell back into negative growth, as the stock slump in June slashed the profitability of the financial sector.

The financial sector contributed almost one-fifth (or 1.3 percentage points) of the 7% GDP in Q1, and was expected to contribute even more in Q2, which helped it grow more than anticipated at 7%. Therefore, the weak industrial profits would suggest that Chinese growth in the third quarter may be impacted by the expected lower contribution from the financial sector. Furthermore, manufacturing activity remained on the soft side. Industrial production stayed unimpressive on the year, hovering at around 6-7%.

Needless to say, we will be watching the Chinese equity markets closely. More specifically, it would be interesting to see what else the Chinese government can roll out to defend the markets. The CSRC said late Monday that the China Securities Finance Corp will step up its stock purchases at appropriate times. The regulator also pledged to ‘stabilise the market’ and ‘prevent systemic risks’. Meanwhile, WSJ reported that the CSRC is not ruling out the possibility that individual big shareholders had coordinated ‘malicious’ short sales, leading to Monday’s plunge. The securities regulator has vowed to root out such practices.

China has been directing support measures to two main objectives, namely, boosting demand and curbing supply. On the demand side, they have thrown money at the equity markets, getting local brokers and mutual funds to come up with funds to buy stocks. On the supply side, they have suspended IPOs, permitting trading halts, imposing a restriction on short selling and threatening investors of the consequences of ‘malicious’ stock sales. My best guess is they may continue doing all of the above, including increasing the magnitude, if necessary. Clearly, they recognise the arguable negative impact of managing the stock market from supply-side measures, therefore the knee-jerk reaction was to step up demand-side actions.

Asia to see more pressure

Risk appetite is clearly on the back burner as China spectacularly returned to the headlines. Commodities continue to experience heavy selling pressure. WTI fell further, chalking up almost 25% in losses within six weeks. Gold remained capped below $1100, keeping calls for $1000 an ounce alive. These cautious undertones will continue into the Asian session. The Straits Times Index fell convincingly through the 3350, dropping nearly 40 points on Monday. The 3300 is going to be seen as a key support.

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