Massive volatility in China. Why?

Traders saw massive volatility in the China A50 and CSI 300 index yesterday – it’s not every day you see a 9.3% and 7.7% respective decline in these equity markets.

Source: Bloomberg

I question what kind of event we would need to see to cause a 9% move in the S&P 500 or ASX 200. Realistically, it shows just how much further the Chinese market has to travel to be seen as a safe investment by international investors.

There are really two issues at hand.

Firstly, China’s securities regulator (the CSRC) tightened rules on banks’ margin trading business, which allows traders to borrow money to buy securities. This new measure will impact 12 brokerages. However, the three biggest brokers have also been told they can’t actually open any new client accounts for three months.

This is a measure designed to curb speculation, as the absolute level of margin loans has grown some 70% since October. This has shown a strong correlation with the equity markets, which in turn have rallied some 50% in the same time frame.

On the other hand, the banking regulator (the CBRC) has put regulations in place for banks’ entrusted loans. Entrusted loans are effectively loans made from one non-financial institution to another, with a bank acting in between.

However, rather than these loans making their way into the real economy what has been occurring here is the funds have been making their way into the capital markets. Going forward, the CBRC has banned these loans from being invested in bonds, futures, derivatives and wealth-management products.

In theory, one could make an argument that the moves are actually positive for the likes of the AUD, commodities and the ASX 200, as it removes some of the rampant speculation in the equity market – there was always a risk it could have been unwound spectacularly.

It also means the funds that have been deployed in the equity market may be rerouted into the real economy, which could support growth. Going forward Chinese banks’ valuations are not expected to be that great, but clearly for traders looking at the CSI 300 or A50 indices, a major short-term driving force has been taken out of the market.

If we look at the A50 index from a technical perspective, the index has found good support at the 10,000 level. This seems to be the key buy zone for traders in the short term. However, the strong trend seen since October last year is over and the possibility of sideways trade is high in the coming weeks.

It’s not often you see the key Chinese regulators putting in measures to cool speculation. What authorities want, they get!

This suggests it might be better to stay cautious on these markets. When you see a near-10% move, there will no doubt be heightened volatility as traders work out a fair market value.

Keep an eye on how the Chinese market reacts to the raft of Chinese economic data out at 13:00 AEDT. 4Q GDP is expected to tick down to 7.3%, while industrial production, fixed asset investment and retail sales are expected to grow 7.4%, 15.7% and 11.7% respectively.

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