Taming China’s soaring shares

If you were an individual trader in China stocks last week, you could be forgiven for being fearful of a market crash being deluged with correction calls from many analysts.

The People's Bank Of China ( PBOC) headquarters stands in the financial district of Beijing
Source: Bloomberg

What prompted the doomsday prediction was the 6.7% plummet in the CSI 300 Index on Thursday 28 May after a number of brokers tighten margin financing and news that the People’s Bank of China (PBOC) is draining liquidity from the banking system.

While the overreaction was understandable, with valid concerns around the probably wanton use of leverage to finance stock purchases, many seems to have missed the bigger picture.

Chinese equities remain on an uptrend, underpinned by solid potential drivers. Tellingly, PBOC did not address the China’s soaring stock prices in its 2015 financial stability report, only saying that it will continue to promote a stable and healthy equity market.

One can reasonably interpret PBOC’s reticence on the bull market as a quiet confidence that Chinese shares are not in a bubble. Either that, or it prefers to leave the risk warnings to the China Securities Regulatory Commission (CSRC), unless things get extremely out of hand.

I have stressed on many occasions that the dominance of retail investors in the China stock market means that it is more susceptible to wider swings. Retail traders account for around 80% of the trading volume.

In the first five months of this year, more than 28 million new A-share accounts were opened, almost equalling the total number of new accounts opened in the past-four years! But crows of an over valuations may be overplayed. The current price-to-earnings ratio of CSI 300 is seen at 21.4 times trailing 12-month earnings, compared to the 38.4 times back in 2007.

Moreover, China’s commitment to liberalising its A-share market is expected to bring stability to the domestic capital markets as foreign funds increase their exposure to Chinese equities. Come next Monday, 6 June, MSCI will decide whether it will include A-shares into its Emerging Market Index. If it does, it would change the dynamics of global fund investment as many international money managers will be snapping up Chinese stocks.

In the meantime, tighter regulations around margin trading should be taken as a positive move for the longer-term. Nonetheless, as we have seen in January and May, moves on margin lending will continue to bring short-term volatility.

The CSI300 posted a very strong rebound on the first day of June, rallying almost 5% and back above 5000. It is therefore crucial to maintain a wider view of the Chinese capital markets, while riding out the near-term waves.

Another week of event risks

Overnight leads provide few clues of how markets in Asia may perform today. Although, I am of the view that cautious undertones will be the order of the day given another weekly minefield of event and data risks. ECB and RBA policy meetings are scheduled for this week, while non-farm payrolls on Friday will be the key data to watch.

This is particularly rather mixed as US data with personal spending flat from the previous month, while construction spending reached the highest in over six years. Added to the data and central bank meetings are Greek’s IMF repayment and OPEC meeting due on Friday 5 June. As always, we continue to be on the lookout for more news out of China, especially on measures aim at tempering the local equity markets.

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CFD’s zijn complexe instrumenten en brengen vanwege het hefboomeffect een hoog risico mee van snel oplopende verliezen.