The current bursting of China’s equity bubble is almost taking focus from Greece’s literal position on the edge of Europe. Shanghai listed equities, now -30%, are well into bear market territory (>20% fall) having turned on a sixpence from their mid-June peak and with massive regulatory intervention (stinking of desperation) failing miserably to keep afloat a ship which had been the market darling of the prior 12 months having more than doubled (+150%).
Authorities are throwing everything and anything they’ve got at putting a floor under share prices with measures including encouraging company share buybacks, share suspensions, using the central bank’s balance sheet, IPOs being suspended to maintain appetite for existing listed stocks, interest rate cuts, lower trading costs, relaxed margin requirements, relaxed bank capital requirements to free up liquidity, rescue funds, coordinated buying and now, as often happens, short-sellers being made scapegoats. However, none of it is working. Equities continue to tumble. What next? The state buying shares?
What’s the problem? Why the panic? While markets naturally rise and fall over time, it’s because China’s equity markets had pretty much only risen from last summer (after years of lackluster performance) and the turnaround of the last few weeks having been so sharp. The saying remains true, “the trend is your friend, until the bend at the end”. The turnaround also coincides with a worsening of the situation regarding Greece, MSCI postponing its inclusion of mainland China shares in its indices and concerns about an overheated China IPO market having pushed Chinese equities into overvalued territory.
The China (Government Intervention) Syndrome
It’s also the fact that Chinese government intervention is what created the mess in the first place – a big driver behind its equity markets doing so well. While the US financial-turned Eurozone sovereign debt crisis saw the world look to faster-growing China to take up the slack of slower global growth, Beijing has been doing everything in its power to stimulate things domestically in order to keep growth at levels considered acceptable by financial markets (GDP >7%). All the while its growth is slowing naturally and inevitably from envious rates posted over the past two decades. One way of helping was to boost consumer confidence and thus spending/consumption, helping domestic growth offset slower exports demand from the rest of the world (US, EU).
While low interest rates helped boost China’s property market for a good while, this became overstimulated, peaked in early 2014 and has been deflating since with ghost towns prevalent and many developers in debt. What to do in the meantime? The public needs something else to feel good about, so retail investors (not necessarily with any understanding of markets) were encouraged via easy access to leverage (unavailable during last China bull market) to trade a hitherto ‘rising’ equity market. To give you an idea, over 12m retail trading accounts were opened in May alone before the market peaked.
While the number of accounts is not a problem in itself, the fact that margin trading (small deposit, borrow the rest) has been so readily available and popular (because China equities and IPOs only ever go up) means the recent market turn has rapidly put those unfortunate enough to be late to the party almost immediately into margin calls. Forced selling adds fuel to the fire, as does confidence-denting market declines which see those back at breakeven want out and those in profits want to lock in gains. Ironically, the Chinese equity market peak of mid-June looks to coincide with some data suggesting a potential bottoming of China house price declines. Part of the grand plan? Fortunate timing? Focus back to property? Or time for something else to make it a bubble hat-trick?
Intervention may be useful to help get things going, and more may be tempting to keep things ticking over, however, constant interferences aimed at inflating - keeping markets inflated can clearly only end badly. As with a bad trade, admitting you're wrong may hurt, but ignoring the fact can hurt even more. The natural bursting of an overheated market may sting, but intervention to the bitter end is only going to hurt more.
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