Fragility of market sentiments

Any long-term investors would tell you that short-term fluctuations are just noise when you have a longer-time horizon. However, people are generally (and naturally) more interested in the now rather than the later. 

Oriental Tower in China
Source: Bloomberg

It appears that Tuesday may not be a good trading day for traders interested in China's financial markets. Chinese shares started on a cautious tone before aggressive sellers appeared in the afternoon. The main stock indices plunged over 6%, with CSI 300 tumbling 6.2%.

It seemed that market participants were once again unduly misinterpreting the news. According to Bloomberg, the CSRC, China securities regulator said last Friday that the government agency, China Securities Finance Corp (CSFC) who has been supporting the stock markets by discretionally buying selective counters, mostly blue-chips and railway stocks, will reduce buying as the market stabilises.

If this is true, then it bears similarity to the 8% plunge on Monday 27 July, where rumours that the government quietly withdrew liquidity meant for stock purchases, caused a massive offloading of Chinese equities.

Although it seems a little strange to me that it took them so long to digest Friday news before acting on the speculation, the more probable reason is that investors are unconvinced by news that the government will announce State Owned Enterprise (SOE) reforms as soon as this week.

The last time we had chatter about SOE reforms back in March, domestic equities rallied, particularly the Shanghai Composite that has a huge proportion of SOE stocks. This time round, the reaction is quite the opposite. According to Chinese market data provider WIND, SOE reform shares fell 8.4% on average today, which is significantly sharper than the overall stock indices.

Nonetheless, if the authorities do unveil plans to reorganise the SOEs, it will be welcomed and sentiments should be bolstered. Furthermore, Bloomberg noted that some speculative funds have liquidated their long positions after making gains in the morning session.

Adding to the jitters are concerns over liquidity in the Chinese economy. As my colleague Angus Nicholson pointed out, indicators of Chinese liquidity such as the offshore CNY one-year interest rate swap and one-week Shanghai interbank rate have been steadily rising, suggesting tighter credit conditions.

As a corollary, the PBOC injected CNY 120 billion worth of seven-day reverse repo into the money market, the largest cash infusion in nearly 19 months. This signalled Beijing’s mounting worries about capital outflows. However, these are all very short-term measures. A more powerful policy tool would be to adjust the reserve requirement ratio (18.5% for major banks), which is considerably higher than its historical average.

Asian equities were mostly lower on Tuesday, with the exception of Malaysia, whose benchmark index, the KLCI, was up modestly. However, this rebound came after a sharp slide for much of August as the country faced a litany of pressure, including persistent declines in oil prices, 1MDB scandal, prospects of worsening public finances, among others.

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