Talking Point

A rollercoaster week

Has the bull run in Chinese stocks just ended, or just paused?

A man watches a board showing stock prices at a brokerage office in Beijing,

Sell in June and go away: Chinese stocks have plunged 25% since June 12

For Chinese investors the term “clash of the titans” means something earthier than Greek gods wrestling each other. Instead they use the phrase to refer to the conflicting messages emanating from the powerful regulators that sit within the Chinese government. It is not a term used fondly, since those clashes have tended to cause retail investors to suffer.

One classic case occurred on May 30, 2007. That was the day the number of brokerage accounts in China broke the 100 million mark. It was also remembered for the “530 catastrophe”, when the Shanghai Composite Index (SHCOMP) tumbled 6.5%. The index – which had doubled in the previous six months – beat a retreat of 15% in the first week of June.

The trigger for the reversal was a decision by the Ministry of Finance to triple stamp duty on stock trading. According to newspaper CBN the tax hike was announced without bothering to notify the China Securities Regulatory Commission (CSRC). Up till then the market watchdog had denied that an increase in the levy was imminent. This led to a tense standoff between the CSRC and the Ministry of Finance. Retail investors – who had been buying on the assumption the government was backing the rally – sensed a policy shift.

More recently A-share investors have had an eerie sense of déjà vu. A breathless stock run sent the SHCOMP 150% higher since late last year. But on May 28 the index dropped more than 6% (on record turnover). In the weeks that followed a steep correction began.

Again A-share investors have been spooked by clashing policy signals from different Chinese regulators. The CSRC, for instance, has been working to contain the exuberance by tightening up on margin trading. The People’s Bank of China (PBOC), on the contrary, has poured liquidity into the market; while Central Huijin Investment – a state-backed fund – has been buying shares to reverse declines. Then at the weekend an interest rate cut looked like the symbolic equivalent of sending in the cavalry. Meanwhile the Wall Street Journal reported the rumour that new IPOs might be halted to prop up demand for existing shares.

Observers are now second guessing whether the crackdown on margin trading signals the rally is over, or whether the government remains happy to see the market go higher. At this volatile juncture, it’s looking like an expensive guess to make…

How bumpy has the market been?

Chinese stocks are still up about 30% in the first half of this year and the SHCOMP rem­­­­­­­ains the best performing equity index in the world. Then again, it has been a very bumpy ride – especially during the last few trading days of June.

After climbing to a seven-year high of 5,178 on June 12, the SHCOMP has taken a tumble. In the 11 trading sessions that followed, the index dipped 21.5% (a 20% decline is officially defined as a bear market).

That means that Shanghai-listed stocks have lost nearly $1.2 trillion in value since June 12, the Financial Times pointed out, which is almost the size of the combined market capitalisation of Spain’s four stock exchanges. And that is not counting losses in Shenzhen, China’s other major bourse.

The most breathtaking episode occurred on the last day of June. At one point on Tuesday the SHCOMP was down as much as 5.1%, only to sustain a remarkable rebound after lunch (on Twitter, one wit asked what investors had eaten and drew an analogy with Popeye opening a can of spinach, and restoring his strength). Thus by market close the index had swung 5.5% higher to close at 4,277, a notch above bear territory.

It was the SHCOMP’s biggest one-day gain since March 2009. The gauge swung 432 points from the high and the low, which also marked the biggest intraday swing since 1992. The scale of this dramatic rebound left most analysts lost for words.

“The market was 150% up in the year through June 12. It took just two weeks for the bear market to form. And now here come this armageddon-intraday-reversal. Chinese investors have seen it all in a month,” a columnist summed up on Sina Finance.

Why the latest correction?

More experienced market observers have been warning for months that the A-share market was overbought. “A rise of 150% in a short period of time is excessive by any standard of the imagination… the rate of acceleration is a classic bubble and some of that is coming off right now,” Stephen Roach, senior fellow at Yale University told CNBC.

“Most Chinese investors,” an analyst told the Wall Street Journal, “are accustomed to believing each bull market is short but the bear market is long.” Another thing they all know, or think they know, according to the same paper, is that “Beijing controls the overall direction of the market”.

In such a policy-driven environment, any mood-dampening move or statement from a government body can lead retail investors to conclude the party is over, and dump their portfolio. Official media plays a role in this, often sending advance warnings. The People’s Daily, for example, cautioned in early April that “the era of ‘all’ people speculating on stocks” has dawned and advised investors to beware. (Indeed, Bloomberg noted this week that there are more than 90 million individual investors in the country, and they now outnumber the country’s 87.8 million Communist Party members.)

Many of the recent dampeners have come from the CSRC too. Since April the stock market regulator has repeatedly sounded its concerns that domestic brokerages have been too aggressive in growing their margin financing business. In fact, the number of such leveraged wagers has jumped five-fold this year, while the outstanding balance of margin financing doubled to a peak of Rmb2.27 trillion ($366 billion) on June 18. (Its rapid growth was something WiC warned about in its Focus issue on the A-share market, published on March 6.)

“Margin financing was the primary market driver on the way up, and it will be a key driver on the way down as well,” Steven Sun, HSBC’s head of Hong Kong and China equity research, wrote in a report last week. Sun and his team also noted that the margin trading balance has since declined by 6%, or Rmb140 billion, in a matter of five days.

“This (margin financing) is new to most retail investors. It’s a risky strategy that few have good experiencse in. There is no question that the CSRC is working to deleverage the system and to deflate the bubble,” the Guangzhou Daily thought.

So are there clashing policy signals from Beijing?

Investors trying to take cues from financial regulators have received mixed messages in the past three months.

In mid-April, the CSRC banned a type of financing tool known as “umbrella trusts” that provided cash for margin trading. It also imposed stricter limits on borrowing against highly risky smaller stocks that trade over the counter (OTC). The moves erased a big chunk of liquidity from the stock market. But just as it employed these dampening measures, the PBOC stepped in a few days later and lowered the reserve requirement ratio (RRR) for all banks by 100 basis points.

A similar episode occurred late last month. A consultation paper by the CSRC – which aimed at further tightening margin financing rules and thus choking off market liquidity – again led to sell-offs. But the Chinese central bank yet again came to the rescue, cutting interest rates by 25 basis points to 4.85%. The cut, the fourth since November, brought the benchmark lending rate to a record low.

“The titans are clashing and small retail investors have become the victims,” financial website Hexun opined.

“Are the CSRC and PBOC working together to drive us crazy?” a commentator wrote on National Business Daily. “The central government has said it wants a ‘slow bull’ [a bull market that develops slowly]. It looks like the PBOC is put in charge of growing the bull while the CSRC is responsible for keeping it slow.”

Let’s not forget there are many other government bodies that can also engineer a market-moving policy whenever they feel the urge. Central Huijin, the investment fund which owns majority stakes in the country’s big financial firms, helped trigger a market rout on May 28 when it sold $585 million worth of its banking shares. But this Tuesday Central Huijin pivoted: domestic media reported it was back in the bull camp snapping up ETFs of index heavyweights.

The Ministry of Finance went into action too, announcing on Tuesday that the new draft rules – from the social security ministry – were set to permit the state’s pension fund to buy stocks. It was estimated the move could see up to $100 billion of fresh funds enter the market.

Rumours – for long the lifeblood of the Chinese equities business – also went into overdrive. The Economic Observer suggested that the government was considering a reduction in stamp duty, to encourage more stock trading. Then there was the idea that the regulator would delay bigger IPOs in the interests of market stability.

The spreading of gossip got so bad that the nation’s media watchdog even issued a directive late last month requesting that all radio and television broadcasters cut back on reports about the stock market in order to “prevent false reports from triggering dramatic rises and falls”.

Where’s the market heading now?

That’s the multi-billion dollar question that analysts have been pondering.

HSBC’s Sun believes it’s premature to call an end to this policy-driven A-share rally, given the importance of the stock market in helping state firms as well as key industries to obtain much-needed financing. “Policy support could prevent further sharp market falls; yet investors will likely sell into the rebound to lower their leverage,” Sun wrote in a recent report.

Following the extraordinary V-shape reversal on Tuesday, the Financial Times noted that Beijing’s efforts to revive swooning share prices are beginning to bear fruit, while “adding weight to the view that the government will do whatever it takes to avert a collapse in the stock market”.

Even the normally hawkish CSRC appears to have softened its stance, issuing a statement this week that an “excessively fast correction” was not healthy. Late on Wednesday it also eased its margin lending rules to resuscitate confidence (specifically it allowed brokerages to set their own parameters for when they need demand additional collateral from clients).

The latest market slump, according to the Securities Times, was the “first major test” for the A-share market since investors were permitted to use margin financing to leverage up their bets. It said the correction was designed to highlight the risks of doing so, but not to kill the bull market.

“[Government departments] have acted proactively, forming a Great Wall to maintain stability in the stock market. Finally we have achieved the result we wanted,” the Securities Times said in its editorial, referring to the strong rebound on Tuesday. “The storm is largely over.”

The Asset Management Association of China also saw something rosier ahead. “Beautiful sunlight always comes after wind and rain”, it commented, as it urged its members to “seize the investment opportunity” following the consolidation in Chinese stocks over the past fortnight.

This optimistic view still looks a bit premature: the SHCOMP retreated deeper into bear territory on Wednesday, dipping more than 5%. The slide continued its slide yesterday as the key index fell another 3.5%, closing below the 4,000 level.

But if the “530 catastrophe” is anything to go by, the plunge could be brief. In 2007, the market resumed its rally after a month and went on to surge another 55%. The SHCOMP only reached its peak five months after the stamp duty increase.

The question this time is whether confidence has been too bruised to recover. A 76 year-old retail investor bearishly told the FT on Wednesday: “Even I, an old Party member, don’t believe the regulators anymore.”


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