Dancing with the Chinese market

Chinese authorities and financial institutions have undertaken coordinated actions to stem the bleeding in the equity markets, but it appears that sentiments were hardly swayed.

China
Source: Bloomberg

Chinese stocks continued to fall despite a number of significant government measures, including PBOC easing, a reduction in trading fees and a loosening of margin trading restrictions.

It seems  that the Chinese stock market’s rebound, specifically the Shanghai shares, on Monday was nothing more than a short break.

The shift in market tone from bullish to bearish has seen the Shanghai Composite fall by nearly 30%, over the last three weeks.

Over the recent weekend, Beijing announced a suspension on all new IPOs and worked with local brokerages to establish market stabilisation funds to reverse the rout in equities. Bloomberg reported that 57 Chinese mutual funds pledged to invest another CNY 2.2 billion in their funds.

The latest initiatives appeared to have worked at the beginning of the week, with the main Shanghai Index surging 7.8% right after the open. However, it turned out to be a dead cat bounce as market mood remained sombre, and the opening gains were quickly eroded. By the end of Monday, the Index closed at one-third of the opening bounce. Hardly the boost many were expecting.

Digging deeper into the latest salvo of market-friendly measures, one gets a sense that the authorities are providing support to larger stocks at the expense of small-cap counters. The bulk of the initiatives were geared towards investing in blue-chip exchange-traded funds (ETFs). This was clearly reflected in the China A50 Index, which recovered over 1000 points in the first two days of this week.

In contrast, the ChiNext index, primarily comprised of smaller stocks, plunged further on Tuesday. For the ChiNext, the fall from the 3 June record-high close continued to be relentless, and stood at slightly around -40% as of 7 July 2015.

It is disconcerting how quickly the sharp correction has taken hold and that it looks to go on for a while longer. It was just about one or two months ago when the equity bulls were charging ahead. Most people were of the view that the government will stimulate economic activity amid slowing growth and keep the wealth creation cycle going through a higher stock market.

Subsequently, the series of margin lending tightening swiftly unravelled the bull market. According to Bloomberg calculations, the stock decline in the last three weeks led to a market value loss of $3.2 trillion, which is almost three times the Australian equity market capitalisation.

Blue-chip stability at the expense of small caps

Stability has always been the cornerstone of Chinese rule. It is rather puzzling that Beijing allowed the rally in the stock market to go on for so long. It’s not the time period that was worrying, it was the pace which gotten many concerned about the sustainability and stability of the stock markets.

The considerable increase in volatility in China has caused Chinese authorities a great deal of discomfort. Judging by recent failed attempts to soothe frayed sentiments, many questioned whether the measures come a little too late.

While Chinese stocks are still positive year-to-date, outperforming most global market returns, the reality is that it’s difficult to gauge how far the current slide will go increases the risk that the gains would be eroded.  But perhaps a greater concern is the social and political impact of the retail traders, who have bet (and borrowed) heavily on what was a sure-fire way of making quick money, losing their savings.

What’s more, deleveraging may pose systemic risks to the banking sector. The Financial Times reported that margin financing account for around 17% of Chinese stock capitalisation. In addition, margin lending for stock trading had more than quadrupled over the past 12 months. Margin risks will clearly be a national-level concern, which explains partially why we are seeing the coordinated response.

However, the concerted action so far appears to have little immediate impact. Critics even point towards the CNY 120 billion put up by the 21 local brokers as a drop in the ocean. Hao Hong, a strategist with BOCOM, quipped that the amount won’t last one hour during a trading session, as it pales in comparison to the average trading volume of CNY 2 trillion.

It is clear to me that although the Chinese authorities are trying to stabilise the stock markets, they are only worried about the larger stocks. This does make sense if you take into consideration that the blue chips typically comprise the bulk of the Chinese stock indices. Moreover, they may also take the opportunity to deflate the excessive speculative activity concentrated in the smaller shares.

The lack of help from the officials to support smaller stocks suggest that the companies have to protect their share prices themselves. Bloomberg noted that about a quarter of China-listed firms have filed for trading halts, and most of the requests were from firms listed in Shenzhen, which is dominated by smaller companies. The suspensions have reportedly locked up $ 1.4 trillion of shares, which is about 21% of China’s market capitalisation, as of 6 July 2015.

The upshot is that as long as blue chips are not stabilised, Beijing will do more to support the Chinese equities.

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