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.

China
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.

China A50
Click to enlarge

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This information has been prepared by IG, a trading name of IG Markets Limited and IG Markets South Africa Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. International accounts are offered by IG Markets Limited in the UK (FCA Number 195355), a juristic representative of IG Markets South Africa Limited (FSP No 41393). South African residents are required to obtain the necessary tax clearance certificates in line with their foreign investment allowance and may not use credit or debit cards to fund their international account.