This special edition of Bloomberg Brief monitored developments in China amid the summer's stock market rout. It was last updated on July 17, 2015. For more on this subject, check out our daily Economics Asia Brief, which publishes at 6:30 a.m. Hong Kong time, and our weekly China Brief, delivered in English and Chinese every Tuesday. Terminal subscribers can find them free here; others can sign up for a free trial online.
China's Stock Boom Boosted GDP, Raising Questions
China’s frenzied stock market boom, which soured in the second half of June, helped drive a surge in financial sector growth that underpinned the economy’s better-than-expected gross domestic product result.
Financial services surged 17.4 percent in the first six months from a year earlier, according to China’s statistics authority, as exchanges and brokerages registered surging revenue amid record trading volume. It was the stand out industry as real estate languished and agriculture grew at about half the overall economy’s pace of 7 percent.
The data underscores the fragility of China’s growth in the quarter, as a rout that wiped almost $4 trillion in equity values may shake confidence in the sector. That could dent hopes for a pick up in the economy in the second half.
“To the extent that growth was supported by financial sector gains from the stock market, it won’t be sustained without further stimulus,” Bloomberg economist Tom Orlik wrote in a note after the quarterly GDP release on Wednesday.
Stock Slump May Hinder Third Quarter Growth, Survey Says
A drop in the Shanghai Composite Index since June 12 will trim at least 0.1 percentage point from third quarter GDP growth and may prompt the PBOC to accelerate monetary easing, according to a survey. Two-thirds of economists say the fall in stock prices will reduce third quarter growth by between 0.1 and 0.6 percentage point, while the rest expect the rout to have negligible impact on Chinese output. Economists forecast 6.8 percent growth this quarter and 6.9 percent in the third and forth quarters of this year, according to a separate survey. China expanded 7 percent in the first quarter, the slowest pace since the beginning of 2009.
— Cynthia Li, Bloomberg News
China’s stocks erase declines as smaller companies advance. The Shanghai Composite index rose 0.3 percent, reversing earlier loss of 3.1 percent. The CSI 500 index of small companies added 2.5 percent after falling 4.4 percent earlier.
Stock Trading Halts Drop by 96 to 24% of Total Listings
A total of 689 companies were suspended from trading just after the 9:30 a.m. open on mainland Chinese exchanges Wednesday, down from 785 on Tuesday.
China Crash ‘Way Bigger Than Subprime’
Hedge fund manager Paul Singer said that China’s debt-fueled stock market crash may have larger implications than the U.S. subprime mortgage crisis.
“This is way bigger than subprime,” Singer, founder of hedge fund Elliott Management, said at the CNBC Institutional Investor Delivering Alpha Conference in New York in response to a question about China’s crash potentially affecting other markets. Singer said it may not be big enough to cause a global financial market conflagration.
“China is a bigger global threat by far [than Greece],” said Bill Ackman, who runs Pershing Square Capital Management. “The Chinese stock market is a fairly remarkable phenomenon and I think kind of a frightening one.”
News & Analysis
P2P Lenders in Cross Hairs as Regulators Curb Share Loans
China’s online lenders are in the cross hairs as regulators take aim at the once-booming business of arranging loans for stock market investment.
The China Securities Regulatory Commission said over the weekend that it would ban online sites from handing out new loans for share purchases, blaming some “information technology service providers” for illegal securities practices which it said contributed to the recent stock market crash.
Combined with the recent drop-off in demand for borrowing to purchase shares, the regulator’s action is likely to add to the troubles of an industry where some lenders have already gone out of business.
“China’s online peer-to-peer lenders are hit by a double whammy,” said Xu Hongwei, chief executive officer of Yingcan Group, a research firm that tracks China’s more than 2,000 P2P platforms. “The regulator pretty much gave a death penalty to the stock-financing business.”
Until recently, the CSRC showed little interest in curbing China’s online lenders, who helped fuel a market roller-coaster that saw the benchmark Shanghai Composite index rallying more than 150 percent in the 12 months through June 12 before plunging.
Online sites offered 3.1 billion yuan ($499 million) of new loans for stock investment in May, about six times the amount offered in January, according to Yingcan data. Many sites quickly adjusted their businesses to emphasize high interest lending for stock market speculation, rather than the traditional P2P loans for small Chinese companies.
As the share market started to slide last month, new loans began to dry up. Online lending for share purchases fell 15 percent in the week beginning June 22, and another 10 percent the following week, according to Yingcan data.
A similar unwinding has been seen in the funding offered by China’s stockbroking firms. The margin finance balance on the Shanghai and Shenzhen exchanges dropped 37 percent to 1.44 trillion yuan Friday from its record in June.
The online sites, which match borrowers with lenders, tend to charge much higher interest rates than those prevailing on the broker accounts and offer more leverage.
After the CSRC announcement, a number of online sites have issued statements confirming they will withdraw from the stock lending business.
Miniu98, one of the largest, said on Monday it will stop lending money for share purchases, as did Xunqianwang, a Wenzhou-based company that started online stock financing in August.
Others were already in difficulties after some borrowers saw their investments wiped out in the market crash. Zhongxin Quick Loans, an eastern Jiangsu province-based company which lends to both individuals and corporates, issued a statement earlier this month saying it is liquidating its assets because its borrowers cannot repay their loans and investors are demanding their money back. Bangcheng Financial, another online lender based in Fujian province, said it is restricting payments to investors offering loans on its site after too many tried to cash out.
Officials at Zhongxin Quick Loans and Bangcheng couldn’t be reached for comment.
Yingcan’s Xu said many online lenders will survive by going back to traditional business of lending to Chinese companies. “It’s fortunate that they are just one of more than 10 lending businesses that P2P firms are offering, so I don’t think the crackdown on stock-related financing will crash the industry,” Xu said.
Among the larger P2P sites, the proportion of loans for stock purchases at Guangzhou-based PPmoney.com had already dropped to 20 percent of the total from 30 percent previously, as a result of investor caution following the stock market decline, according to the company’s co-founder Terry Hu. The company has extended total loans of around 15 billion yuan.
PPmoney said on Tuesday it will comply with the CSRC’s regulations and has stopped adding new clients or loans for stock purchases. The platform will explore the idea of applying for a license to invest in stocks, said PPmoney spokeswoman Chen Yi.
“For those P2Ps that are lucky enough to survive the latest turbulence, they need to think where they want to go from here,” Yingcan’s Xu said. “Maybe the solution is going back to what they are supposed to do: matching borrowers with lenders.”
Most Chinese Stocks Rise in Volatile Trade
Most Chinese stocks rose in volatile trading as rallies for drug and consumer companies overshadowed losses for banks. About three stocks gained for each one that fell on the Shanghai Composite Index, which slipped 0.1 percent to 3,801.25 at 10:04 a.m. local time. The benchmark gauge swung between a loss of as much as 3.1 percent and a gain of 0.5 percent as 100-day volatility jumped to the highest level since March 2009. A total of 673 stocks were halted on mainland exchanges, or about 23 percent of all listings.
Stock market gains sparked by unprecedented government intervention are reversing as hundreds of companies resume trading and the government cracks down on margin lending from unofficial sources. Hundsun Technologies Inc., which is being probed by the securities regulator, stopped account openings in its HOMS system, which was developed to virtually facilitate non-brokerage margin lending.
“Investor confidence is already damaged,” said Ronald Wan, chief executive at Partners Capital International in Hong Kong. “They are too cautious to take long-term views on the market. People still want to get out but in an orderly way. The market remains in a consolidation stage.”
The CSI 300 Index lost 0.1 percent. The CSI 500 Index of smaller companies climbed 0.5 percent. Hong Kong’s Hang Seng China Enterprises Index slid 0.7 percent, while the Hang Seng Index dropped 0.4 percent.
Jiangsu Hengrui Medicine Co. led gains for health-care companies, rising 5.2 percent. A gauge of financial companies in the CSI 300 fell 1.7 percent for the steepest loss among 10 industry groups.
Market Reaction
China May Tip World Into Recession: Sharma
Forget about all the shoes, toys and other exports. China may soon have another thing to offer the world: a recession. That is the prediction from Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management, who says a continuation of China’s slowdown in the next years may drag global economic growth below 2 percent, a threshold he views as equivalent to a world recession. It would be the first global slump over the past 50 years without the U.S. contracting.
“The next global recession will be made by China,” said Sharma, who manages more than $25 billion. “Over the next couple of years, China is likely to be the biggest source of vulnerability for the global economy.”
China’s economy will continue slowing as the country struggles to reduce its debt, Sharma said. An additional 2 percentage-point slowdown would be enough to tip the world into a recession, he said. The global expansion, measured by market exchange rates, has slipped below 2 percent during five different periods over the past 50 years, most recently in 2008-09. All the previous world recessions have coincided with contractions in the U.S. economy.
China’s stock market collapse has challenged some investors’ long-held conviction that the Chinese authorities have an adequate grip on the economy and markets and that the government is always able to achieve its goals, said Sharma.
“What happened in China last week was so significant in that for the first time, you’ve got this sign that something is out of control,” Sharma said. “Confidence damage is going to last for a while.”
China’s Credit Expands in June as Stimulus Efforts Kick in
China’s broadest measure of new credit increased the most since January after the government stepped in to boost provincial finances and the central bank accelerated monetary easing. Aggregate financing, which includes bank loans and off-balance-sheet credit, was 1.86 trillion yuan ($300 billion) in June, according to the People’s Bank of China, higher than all 23 forecasts in a Bloomberg survey of economists. The pick-up suggests that relaxed rules for local authorities to get financing and record-low interest rates are boosting demand for credit. China’s leadership strengthened its policy response in face of a slowdown in growth — estimated at 6.8 percent last quarter — and a stock-market rout that at one stage had wiped almost $4 trillion off equity valuations. “The data is a good signal: The economy is recovering on a pickup in investment,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong. Relaxed local government financing rules “will continue to drive infrastructure investment in the third quarter.” Stocks gained after the lending report, though slid in later trading. The Shanghai Composite Index was down 0.3 percent as of noon local time, after advancing the past three trading days amid a concerted effort by officials to halt drop.
— Xiaoqing Pi, Bloomberg News
market calls
Chinese equities are in a long-term bull market despite a recent market slump, Eclectica Asset Management’s Hugh Hendry said. Investors should buy Chinese stocks after unprecedented economic stimulus by the government and the end of a rally in commodities, rather than betting values are unsustainable, the fund manager said.“China is very, very much like the Europe of 2012,” said Hendry. “There is a textbook response. Banks can do alchemy. They can take that bad paper and use it as collateral and you get free money to put back into the economy.”
Kinger Lau, China strategist at Goldman Sachs, predicts the large-cap CSI 300 Index will rally 27 percent from July 7 close over the next 12 months as support measures boost investor confidence and monetary easing spurs economic growth. Leveraged positions aren’t big enough to trigger a market collapse, Lau says, and valuations have room to climb.
Fidelity Investments says that Chinese stocks are a buy following the worst selloff in two decades. “As far as the fundamentals are concerned, we are actually quite confident,” said Robert Bao, a money manager at Fidelity. “We are fully invested.” Government efforts to stabilize the market will keep the rout from spilling over to the broader financial system, Bao said.
There is a decent chance of “another leg down” for stocks within the next few months when the government starts to withdraw its support in terms of liquidity, said David Cui, Bank of America’s head of China equity strategy. Unless the government keeps pushing the market higher, selling pressure will probably “stay relentless” because of leverage, he said.
“Valuations are still about double where they were last summer,” said Russ Koesterich, the global chief investment strategist at BlackRock. “Given the magnitude of the run-up, it is possible that even after a 30 percent correction, we haven’t gotten back to something approaching fair value.”
Reform
China Leadership, Optimal During Boom, Faces Tougher Tasks
Since Deng Xiaoping kicked off China’s modernization drive in the late-1970s, Chinese officialdom has proudly overseen an unrivaled run of high-speed growth. The country’s rapid rise elicited awe and admiration abroad — and solidified the legitimacy of the one-party and authoritarian Communist Party at home.
In recent years, though, it sometimes seems the country’s admired economic technocrats have been replaced by a jazz improvisation group, composing policy on the fly. China’s latest growth rate came in at 7 percent, better than forecast, but there’s no denying it has decelerated markedly from the double-digit average seen from 1980 to 2012. And it remains below the increase in debt.
Nor has this been a stellar year for President Xi Jinping’s economic team. First the government urged people to buy stocks, helping to inflate a bubble that exploded in mid-June, wiping out almost $4 trillion in market value. Then, with the subtlety of a chain-saw, the government intervened in the market with a barrage of measures to boost prices, leaving valuations untethered from economic realities on the ground.
Years of politically driven investment with diminishing returns, meanwhile, has led to a $28 trillion debt overhang, according to McKinsey & Co., and excess industrial capacity. In April, Shenzhen-based Kaisa Group Holdings Ltd., became the first property developer ever to default on dollar-denominated debt.
Political System
“China’s political system was a great facilitator of the first wave of economic reforms post-1978,” said David Shambaugh, director of George Washington University’s China Policy Program. “Now and into the future it is the greatest single impediment to further decades of reform and growth.”
China is not the first country to let a roaring stock market run off the rails or ignore the risks of an expanding credit bubble. Nor do the recent stumbles negate the rise of what’s now the world’s second-biggest economy.
Yet it’s one thing to run a developing
economy that relies on state-directed lending, cheap labor and plentiful foreign investment, as Chinese leaders did during the 1980s and 1990s. It is quite another to simultaneously pull off modernizing a financial system, rebalancing a big economy toward more consumer-led growth and defusing debt bombs in the property market, companies and local governments. That’s pretty much the task at hand in Beijing.
Different Assignment
The top-down command structure of the Chinese political leadership, with its centralized mechanisms of economic control and secrecy, worked swimmingly during the early phases of the nation’s rise. It may be less of an advantage when it comes to managing a vast, multi-dimensional economy where problems in one sector can quickly shape-shift and create unintended consequences.
While this isn’t Mao’s command-and-control China anymore, the government still plays an out-sized role in credit allocation and monetary policy.
The state’s control proved a boon in the wake of the 2008 financial crisis, when Chinese leaders ordered the People’s Bank of China to slash interest rates, encouraged lending to local governments and kept a lid on yuan appreciation. In 2009 and 2010, more than 17.5 trillion yuan ($2.8 trillion) rifled through the economy as the government embarked on an epic infrastructure binge and fed into a property market bubble.
Spooking Investors
As authorities then tried to rein in liquidity, market disruptions emerged, including a surge in interbank borrowing costs in mid-2013 to a record level that unsettled investors.
The next asset bubble, produced with cheer-leading from the state-controlled media: stocks. The Shanghai Composite Index surged in excess of 150 percent from July 2014 through June 12, even as the economy was weakening.
A thriving stock market allowed China’s debt-burdened companies to announce at least $226 billion this year in initial and secondary offerings. Yet at the same time
millions of unsophisticated and, in some cases illiterate, Chinese retail investors bet their savings on stocks as a revved-up market headed for a severe downturn.
When the bull market turned into a bear one, the flurry of measures unleashed to shore up stock prices then put a severe dent in Xi’s pro-market agenda.
‘Whack-a-Mole’
“They have been good at playing whack-a-mole and containing damage but I don’t think that they have been in control in terms of the trajectory of the economy for the last several years,” said Patrick Chovanec, chief strategist at Silvercrest Asset Management Group.
An even bigger test of confidence in China’s leadership will be addressing an ever-growing reliance on debt to fund growth. Behind Wednesday’s stronger-than-projected numbers was Tuesday’s report of the biggest jump in credit since January — the product of policy makers ramping up efforts to get more money flowing. Outstanding loans for companies and households stood at a record 207 percent of GDP at the end of June, up from 125 percent in 2008, data compiled by Bloomberg show.
“Because the debt burden will continue to rise for at least another four or five years, Beijing’s credibility will be tested more than ever and it must be protected more than ever,” said Michael Pettis, a professor at the Guanghua School of Management at Peking University.
Still Reforming
“The reform program is basically about medium-term issues, over the years to 2020, whereas the stock-market intervention was a response to an immediate and potentially destabilizing risk,” said Tim Summers, senior consulting fellow on Asia at Chatham House in Hong Kong.
Not everyone is convinced.
“The bubble, and the instability it underscores, is a major setback on the road to capital market reform –- a linchpin of China’s rebalancing strategy,” said Stephen Roach, a senior fellow at Yale University and former non-executive chairman for Morgan Stanley in Asia.
Since Deng Xiaoping kicked off China’s modernization drive in the late-1970s, Chinese officialdom has proudly overseen an unrivaled run of high-speed growth. The country’s rapid rise elicited awe and admiration abroad — and solidified the legitimacy of the one-party and authoritarian Communist Party at home.
In recent years, though, it sometimes seems the country’s admired economic technocrats have been replaced by a jazz improvisation group, composing policy on the fly. China’s latest growth rate came in at 7 percent, better than forecast, but there’s no denying it has decelerated markedly from the double-digit average seen from 1980 to 2012. And it remains below the increase in debt.
Nor has this been a stellar year for President Xi Jinping’s economic team. First the government urged people to buy stocks, helping to inflate a bubble that exploded in mid-June, wiping out almost $4 trillion in market value. Then, with the subtlety of a chain-saw, the government intervened in the market with a barrage of measures to boost prices, leaving valuations untethered from economic realities on the ground.
Years of politically driven investment with diminishing returns, meanwhile, has led to a $28 trillion debt overhang, according to McKinsey & Co., and excess industrial capacity. In April, Shenzhen-based Kaisa Group Holdings Ltd., became the first property developer ever to default on dollar-denominated debt.
Political System
“China’s political system was a great facilitator of the first wave of economic reforms post-1978,” said David Shambaugh, director of George Washington University’s China Policy Program. “Now and into the future it is the greatest single impediment to further decades of reform and growth.”
China is not the first country to let a roaring stock market run off the rails or ignore the risks of an expanding credit bubble. Nor do the recent stumbles negate the rise of what’s now the world’s second-biggest economy.
Yet it’s one thing to run a developing
economy that relies on state-directed lending, cheap labor and plentiful foreign investment, as Chinese leaders did during the 1980s and 1990s. It is quite another to simultaneously pull off modernizing a financial system, rebalancing a big economy toward more consumer-led growth and defusing debt bombs in the property market, companies and local governments. That’s pretty much the task at hand in Beijing.
Different Assignment
The top-down command structure of the Chinese political leadership, with its centralized mechanisms of economic control and secrecy, worked swimmingly during the early phases of the nation’s rise. It may be less of an advantage when it comes to managing a vast, multi-dimensional economy where problems in one sector can quickly shape-shift and create unintended consequences.
While this isn’t Mao’s command-and-control China anymore, the government still plays an out-sized role in credit allocation and monetary policy.
The state’s control proved a boon in the wake of the 2008 financial crisis, when Chinese leaders ordered the People’s Bank of China to slash interest rates, encouraged lending to local governments and kept a lid on yuan appreciation. In 2009 and 2010, more than 17.5 trillion yuan ($2.8 trillion) rifled through the economy as the government embarked on an epic infrastructure binge and fed into a property market bubble.
Spooking Investors
As authorities then tried to rein in liquidity, market disruptions emerged, including a surge in interbank borrowing costs in mid-2013 to a record level that unsettled investors.
The next asset bubble, produced with cheer-leading from the state-controlled media: stocks. The Shanghai Composite Index surged in excess of 150 percent from July 2014 through June 12, even as the economy was weakening.
A thriving stock market allowed China’s debt-burdened companies to announce at least $226 billion this year in initial and secondary offerings. Yet at the same time
millions of unsophisticated and, in some cases illiterate, Chinese retail investors bet their savings on stocks as a revved-up market headed for a severe downturn.
When the bull market turned into a bear one, the flurry of measures unleashed to shore up stock prices then put a severe dent in Xi’s pro-market agenda.
‘Whack-a-Mole’
“They have been good at playing whack-a-mole and containing damage but I don’t think that they have been in control in terms of the trajectory of the economy for the last several years,” said Patrick Chovanec, chief strategist at Silvercrest Asset Management Group.
An even bigger test of confidence in China’s leadership will be addressing an ever-growing reliance on debt to fund growth. Behind Wednesday’s stronger-than-projected numbers was Tuesday’s report of the biggest jump in credit since January — the product of policy makers ramping up efforts to get more money flowing. Outstanding loans for companies and households stood at a record 207 percent of GDP at the end of June, up from 125 percent in 2008, data compiled by Bloomberg show.
“Because the debt burden will continue to rise for at least another four or five years, Beijing’s credibility will be tested more than ever and it must be protected more than ever,” said Michael Pettis, a professor at the Guanghua School of Management at Peking University.
Still Reforming
“The reform program is basically about medium-term issues, over the years to 2020, whereas the stock-market intervention was a response to an immediate and potentially destabilizing risk,” said Tim Summers, senior consulting fellow on Asia at Chatham House in Hong Kong.
Not everyone is convinced.
“The bubble, and the instability it underscores, is a major setback on the road to capital market reform –- a linchpin of China’s rebalancing strategy,” said Stephen Roach, a senior fellow at Yale University and former non-executive chairman for Morgan Stanley in Asia.
China's Challenges
Margin for Error — Tracking China’s Stock Leverage
Margin trading accelerated the boom and bust of China’s equity market. Uncertainty about the extent of the leverage is now adding to the perils of a volatile market.
Margin finance rose rapidly to a peak of 2.3 trillion yuan in June from 400 billion yuan a year earlier. That rapid growth took margin finance to 4.4 percent of market cap and 3.2 percent of GDP. While already alarming, these figures don't even take into account the level of margin finance provided by the shadow financial system.
Margin trades through Internet-based platforms may have added at least 400 billion yuan to the total, suggesting the real risk level is far higher than official figures imply. The China Household Finance Survey suggests that for every two household investors borrowing on margin from a broker, there's one borrowing through informal channels.
Worse, while regulated brokers conservatively set leverage limits for investors at 100 to 200 percent, in the shadow sector leverage could be over 500 percent. Shadow leverage is also more expensive, with annualized rates of 20 percent compared with 8 percent.
In sharply falling markets the risk is that investors trading with borrowed funds will be unable to repay loans. In the formal financial system, the first to suffer would be brokers who made margin loans.
China’s 120 brokers hold about 900 billion yuan in capital, versus 1.4 trillion yuan in margin loans. Based on Securities Association of China data, the debt to equity ratio for the sector is about 300 percent — suggesting limited capacity to absorb losses.
The risk then is that banks, a far more central part of China’s financial system, take a hit. Bank loans to the non-bank financial sector averaged 690 billion yuan a month in the six months to May — the period when margin financing was expanding rapidly — more than double the average in the previous year.
All of that explains why China’s government has intervened so aggressively in the margin market. The first move came in mid-June, when the China Securities Regulatory Committee cracked down on shadow margin finance by banning the virtual trading accounts
that are used to circumvent controls on market participation.
Having closed the back door to margin trading, policy makers hastily moved to open the front door to prevent the market crashing. The minimum collateral requirement of 130 percent on margin loans was removed and the central bank waded in with liquidity support for intermediaries forced to roll over loans.
So far, the central bank has provided 260 billion yuan to China Securities Finance Corporation — the state-owned agency that provides funds for margin finance. As of March 2015, the latest data available, CSF had extended 807 billion yuan in loans to brokers, and in July it boosted its registered capital to 100 billion yuan from 24 billion yuan.
Those interventions have broken the vicious circle where falling markets generate margin calls which push markets down again. The Shanghai Composite Index ended Tuesday at 3,924.5, up from a nadir of 3,507.2 last Wednesday. The unanswered question: how many margin trades remain to be unwound?
Margin trading accelerated the boom and bust of China’s equity market. Uncertainty about the extent of the leverage is now adding to the perils of a volatile market.
Margin finance rose rapidly to a peak of 2.3 trillion yuan in June from 400 billion yuan a year earlier. That rapid growth took margin finance to 4.4 percent of market cap and 3.2 percent of GDP. While already alarming, these figures don't even take into account the level of margin finance provided by the shadow financial system.
Margin trades through Internet-based platforms may have added at least 400 billion yuan to the total, suggesting the real risk level is far higher than official figures imply. The China Household Finance Survey suggests that for every two household investors borrowing on margin from a broker, there's one borrowing through informal channels.
Worse, while regulated brokers conservatively set leverage limits for investors at 100 to 200 percent, in the shadow sector leverage could be over 500 percent. Shadow leverage is also more expensive, with annualized rates of 20 percent compared with 8 percent.
In sharply falling markets the risk is that investors trading with borrowed funds will be unable to repay loans. In the formal financial system, the first to suffer would be brokers who made margin loans.
China’s 120 brokers hold about 900 billion yuan in capital, versus 1.4 trillion yuan in margin loans. Based on Securities Association of China data, the debt to equity ratio for the sector is about 300 percent — suggesting limited capacity to absorb losses.
The risk then is that banks, a far more central part of China’s financial system, take a hit. Bank loans to the non-bank financial sector averaged 690 billion yuan a month in the six months to May — the period when margin financing was expanding rapidly — more than double the average in the previous year.
All of that explains why China’s government has intervened so aggressively in the margin market. The first move came in mid-June, when the China Securities Regulatory Committee cracked down on shadow margin finance by banning the virtual trading accounts
Outstanding Margin Financing
Bank Claims on Other Financial Sector
that are used to circumvent controls on market participation.
Having closed the back door to margin trading, policy makers hastily moved to open the front door to prevent the market crashing. The minimum collateral requirement of 130 percent on margin loans was removed and the central bank waded in with liquidity support for intermediaries forced to roll over loans.
So far, the central bank has provided 260 billion yuan to China Securities Finance Corporation — the state-owned agency that provides funds for margin
finance. As of March 2015, the latest data available, CSF had extended 807 billion yuan in loans to brokers, and in July it boosted its registered capital to 100 billion yuan from 24 billion yuan.
Those interventions have broken the vicious circle where falling markets generate margin calls which push markets down again. The Shanghai Composite Index ended Tuesday at 3,924.5, up from a nadir of 3,507.2 last Wednesday. The unanswered question: how many margin trades remain to be unwound?
Reality Check
Stocks Are Still Too Expensive for Mobius
Chinese shares have tumbled faster than any of their global peers, suffered the first bear-market retreat since 2012 and erased more value in a month than the annual economic output of the U.K. After all those losses, is now the time to go bargain hunting?
Not just yet. That’s the refrain from BlackRock, UBS Group and Templeton Emerging Markets Group’s Mark Mobius, who say mainland stocks need to fall further before they’re worth buying. Even after the selloff, China’s Shanghai Composite Index is 89 percent higher than it was 12 months ago. The gauge’s valuation is 50 percent above its five-year average, while the median price-to-earnings ratio on Chinese bourses is the most expensive among the world’s 10 largest markets. With more than 1,300 mainland shares frozen by trading halts, prices may not fully reflect a buildup of selling pressure over the past month.
“Valuations are still about double where they were last summer,” Russ Koesterich, the global chief investment strategist at BlackRock, which oversees about $4.8 trillion, said in a July 10 interview on Bloomberg Television. “Given the magnitude of the run-up, it is possible that even after a 30 percent correction, we haven’t gotten back to something approaching fair value.”
The following four charts show where Chinese valuations stand now.
Shanghai Composite
China’s benchmark index trades at about 20 times trailing 12-month earnings. While that’s down from 26 at the height of the rally in mid-June, it’s still well above the five-year average of 13.4, according to data compiled by Bloomberg. “It’s still expensive,” said Wenjie Lu, a strategist at UBS in Shanghai. “The downside risk for A shares is still big.
Given the heavy weighting of low-priced bank shares in Chinese equity gauges, some analysts prefer to look at the median price-to-earnings ratio instead. In China, that was 57 on Friday, versus 19 for America’s Standard & Poor’s 500 Index, 16 in the U.K. and 13 in Hong Kong.
China’s smaller stocks, some of the biggest winners of the bull market, are still trading at price-to-earnings ratios 45 percent higher than their five-year average. The benchmark ChiNext index is valued at 81 times profit, versus 50 for the Russell 2000 Index in the U.S.
Global Relative Value
The Shanghai Composite trades at a 12 percent premium versus the MSCI All-Country World Index, compared with a 14 percent discount on average over the past five years. “While we are already investing in China, our strategy is to wait until prices are so attractive that it’s time to look for further long-term opportunities,” Mobius wrote in a report. “We believe that point is close with some stocks, but we probably haven’t hit the bottom yet.”.
China'S Equity ROUT in Six CHARTS
One large, messy market. Six charts to describe it.
Crash Eclipses French GDP — Sacre Bleu
From their peak on June 14, Chinese listed stocks have lost $3.56 trillion to July 8, according to Bloomberg's China Market Cap index. That's comfortably more than the entire economic output of France.
Arb Truths
Peak to Peaky
Back to Earth
The price to estimated earnings ratio of the Shanghai Composite is now back below that of the S&P 500 index. Have equities reached a floor? Kinger Lau, a Goldman Sachs China strategist in Hong Kong, predicts that large companies will rally more than 20 percent over the next 12 months.
For more, see: Goldman Sachs Says There’s No China Stock Bubble
View
Hong Kong, China's Real Stock Market, Stays Calm
A market, by definition, is a place where buyers and sellers can come together to exchange goods and services. That involves buying and selling those goods. Once you eliminate that free trading, you no longer have a market.
Then there is China, where the authorities have suspended the sale of 72 percent of the A share stocks. “Investors with stakes exceeding 5 percent must maintain their positions,” the China Securities Regulatory Commission said.
Throughout history, rules and regulations have slowly evolved to markets. Indeed, a certain level of regulation is desirable to ensure fair dealings, transparency and efficiency. By removing the ability to freely sell shares, the Shanghai Stock Exchange no longer qualifies as a market. I don’t know what it is, but if forced to come up with a name, the pursuit of accuracy would suggest calling it a government bureaucracy.
Lest you forgot, China remains a centrally planned autocratic regime ruled by the Communist Party. Niceties such as liquidity and free trading are deviant concepts. Pity Xiao Gang, the chairman of head of China Securities Regulatory Commission. The Wall Street Journal said he had “the toughest job in China.”
Let me suggest to Xiao that he might learn from the mistakes the West made in its recent crises.
During the dotcom bubble, Federal Reserve Chairman Alan Greenspan failed
to do anything to reduce the speculative excesses. Day trading, excessive leverage, mediocre listing requirements all worked to allow a huge bubble.
After years of gains, the Nasdaq Composite Index doubled in 6 months — October 1999 to March 2000 — before its historic collapse of almost 80 percent.
It may be too late for Xiao to learn much from those errors. He has allowed the use of speculative leverage to run amok in China, leading to the inflation of its historic bubble. Greenspan doubled down on his mistakes, slashing rates after the crash, which contributed to bubbles in real estate, credit and commodities. Perhaps Xiao might find that lesson useful.
During the subsequent financial crisis, which had many causes, the Securities and Exchange Commission sided with panicked bankers, implementing bans on short selling. That action subsequently spread around the world.
Ultimately, this kind of action removes a source of buying in a rout. Short sellers are typically the first to buy during a crash. Why? They have no risk in making the buy, as they are closing out an existing position. Thus, they act as a floor under a falling market.
The strongest collapse in U.S. equities took place after the SEC banned short selling in September 2008.
Consider the long buyer in a market selloff: They are catching the falling knife or anvil. They risk being early, and the trade is a money loser. Short sellers suffer no such disadvantage. Indeed, it is not much of a stretch to suggest that every short sale is a future buy.
How ineffective are prohibitions of short-selling? Recall the ban in the 1930s — despite that, the Dow eventually fell 80 percent from its highs.
If stopping short sales does not prevent the occasional market collapse, consider these actual consequences of stopping sales altogether:
Causes markets to suffer a loss of integrity;
Selling halts are blatant market manipulations;
Are likely to cause a huge increase in volatility;
Ultimately creates a huge air pocket, leading to an even bigger crash when trading resumes after the six-month ban ends.
China's state-run Xinhua News reported that "police had visited the China Securities Regulatory Commission to investigate “malicious short selling.” I thought U.S. and European bans on short-selling were counterproductive and short-sighted, I can’t wait to see the result of these moves.
When the A-share market reopens in 2016, a bigger question will remain: Why would anyone want to invest in a market where you might not ever be able to sell?
There are many ways to cause a market crash. This should be one of the easiest to avoid.
China, which has made remarkable progress over the past 30 years, may have just set itself back a decade. Or we just found out we have been fooled by the regime's faux gestures toward capitalism. Either way, it will be interesting to watch this insane experiment unfold.
Not so long ago, Hong Kong was regularly dismissed as a financial backwater — not just internationally, but even within China. Many pundits started writing the city's obituary when Jack Ma, CEO of China's e-commerce giant Alibaba, rejected listing his company in Hong Kong, in favor of New York. And as Shanghai's stocks skyrocketed in recent months, it seemed to confirm Hong Kong's obsolescence.
But the more instructive comparison between the markets in Hong Kong and mainland China has come more recently, as Chinese stocks have started to plunge. Officials in Beijing have panicked, doing anything and everything to stop their stock markets' slide; they've slashed interest rates, boosted margin lending, loosened collateral rules, scrapped IPOs, strong-armed big shareholders, pushed brokerages to buy, and took about 1,300 companies off the market.
Hong Kong officials, meanwhile, have calmly let market forces do their thing as a selling tsunami slammed the Hang Seng Index. Hong Kong's composed and hands-off leaders have been showing Beijing how a mature and open economy is supposed to run.
That's worth keeping in mind this week, as the world obsesses over the release of China's latest GDP figures. Officials in Beijing are likely to report China grew 6.8 percent in the second quarter (although there's reason to doubt the accuracy of whatever number is released). Investors will likely applaud the news, just as they did Monday's announcement that June exports rose 2.1 percent from a year ago.
But the divergent responses to the equities debacle are far more important than China's inflated GDP numbers. And what they tell us is that size isn't everything. Hong Kong is Asia's 11th biggest economy, just barely ahead of the Philippines. Yet, thanks to its low taxes, rule of law, unfettered capital flows and transparent markets, it earns its status as one of the world's freest economies.
The city isn't without economic impediments, including a pegged currency, oligarchs towering over the economy and a leader picked by China (one reason for last year's massive Umbrella Revolution protests). But capitalist mores are clearly ingrained in Hong Kong in a way they're not in mainland China.
When Hong Kong reverted to Chinese rule in 1997, the hope was that Beijing would emulate the city. Twenty years on, optimists said, China would boast a free media, a stable and transparent financial system, and greater respect for human rights. Instead, President Xi Jinping's Communist Party is steadily trying to impose its brand of opacity, censorship and top-down economic-policy making on financial markets.
China will pay a price for not importing more of Hong Kong's sensibility. Xi's wildly-over-the-top moves to manipulate the market higher vindicates MSCI's recent refusal to include what's now effectively a state-backed market in its indexes. That may kill China's hopes to join the International Monetary Fund’s special-drawing rights system; to become a global reserve currency, the yuan has to be reliably convertible.
Beijing is also moving the country's financial froth into even riskier territory, says Marshall Mays, director of Emerging Alpha Advisors. It's nice that the Shanghai Composite Index has rebounded 13 percent in three days. The trouble is, Beijing "had the chutzpah to do it without any premise of earnings growth to support it," Mays says. "Sooner or later even the speculators will figure that out and sell."
Foreigners also may be less willing to invest in Shanghai if they feel like they'll have to constantly be worrying about political machinations in Beijing. Who wants to establish short positions or try hedging a bet on higher prices with China's public security bureau breathing down your neck? Meanwhile, the ongoing anti-foreigner campaign in state-run media is as creepy as it is hypocritical. Xi's government is second to none in the market manipulation department.
The message seems to be that if you want a piece of China's rise, it's best to find a proven and safe entry point. Fortunately, there's one already available — its name is Hong Kong.
Not so long ago, Hong Kong was regularly dismissed as a financial backwater — not just internationally, but even within China. Many pundits started writing the city's obituary when Jack Ma, CEO of China's e-commerce giant Alibaba, rejected listing his company in Hong Kong, in favor of New York. And as Shanghai's stocks skyrocketed in recent months, it seemed to confirm Hong Kong's obsolescence.
But the more instructive comparison between the markets in Hong Kong and mainland China has come more recently, as Chinese stocks have started to plunge. Officials in Beijing have panicked, doing anything and everything to stop their stock markets' slide; they've slashed interest rates, boosted margin lending, loosened collateral rules, scrapped IPOs, strong-armed big shareholders, pushed brokerages to buy, and took about 1,300 companies off the market.
Hong Kong officials, meanwhile, have calmly let market forces do their thing as a selling tsunami slammed the Hang Seng Index. Hong Kong's composed and hands-off leaders have been showing Beijing how a mature and open economy is supposed to run.
That's worth keeping in mind this week, as the world obsesses over the release of China's latest GDP figures. Officials in Beijing are likely to report China grew 6.8 percent in the second quarter (although there's reason to doubt the accuracy of
whatever number is released). Investors will likely applaud the news, just as they did Monday's announcement that June exports rose 2.1 percent from a year ago.
But the divergent responses to the equities debacle are far more important than China's inflated GDP numbers. And what they tell us is that size isn't everything. Hong Kong is Asia's 11th biggest economy, just barely ahead of the Philippines. Yet, thanks to its low taxes, rule of law, unfettered capital flows and transparent markets, it earns its status as one of the world's freest economies.
The city isn't without economic impediments, including a pegged currency, oligarchs towering over the economy and a leader picked by China (one reason for last year's massive Umbrella Revolution protests). But capitalist mores are clearly ingrained in Hong Kong in a way they're not in mainland China.
When Hong Kong reverted to Chinese rule in 1997, the hope was that Beijing would emulate the city. Twenty years on, optimists said, China would boast a free media, a stable and transparent financial system, and greater respect for human rights. Instead, President Xi Jinping's Communist Party is steadily trying to impose its brand of opacity, censorship and top-down economic-policy making on financial markets.
China will pay a price for not importing more of Hong Kong's sensibility. Xi's wildly-over-the-top moves to manipulate the market higher vindicates MSCI's recent refusal to include what's now
effectively a state-backed market in its indexes. That may kill China's hopes to join the International Monetary Fund’s special-drawing rights system; to become a global reserve currency, the yuan has to be reliably convertible.
Beijing is also moving the country's financial froth into even riskier territory, says Marshall Mays, director of Emerging Alpha Advisors. It's nice that the Shanghai Composite Index has rebounded 13 percent in three days. The trouble is, Beijing "had the chutzpah to do it without any premise of earnings growth to support it," Mays says. "Sooner or later even the speculators will figure that out and sell."
Foreigners also may be less willing to invest in Shanghai if they feel like they'll have to constantly be worrying about political machinations in Beijing. Who wants to establish short positions or try hedging a bet on higher prices with China's public security bureau breathing down your neck? Meanwhile, the ongoing anti-foreigner campaign in state-run media is as creepy as it is hypocritical. Xi's government is second to none in the market manipulation department.
The message seems to be that if you want a piece of China's rise, it's best to find a proven and safe entry point. Fortunately, there's one already available — its name is Hong Kong.
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
Billionaires
China's Richest People Just Lost About $100 Billion in a Month
It takes an iron stomach to be one of the richest people in China.
Billionaires from China and Hong Kong who rank among the 400 wealthiest people on earth gained $121 billion this year through June 12, 2015, when equity markets peaked there. They lost almost $100 billion as shares plummeted this month, including $30 billion at the start of the week, before the rally on Thursday and Friday.
"I hope these people realize that it's just paper money,'' said Niklas Hageback, who helps oversee about $202 million at Hong Kong-based money management firm Valkyria Kapital. "I hope for their own personal mental health that they have been able to realize that. Otherwise, if you just start to look at your own income statements, the losses are truly horrendous.''
The rise and fall (and potential rise again) has reshuffled the top echelon of global wealth, pushing the world's most-populous country above all others except for the United States in the numbers of billionaires created and the fortunes they control.
There are 26 billionaires from mainland China who have a combined $262 billion, about 6 percent of the $4.1 trillion held by the world's 400 richest people, according to the Bloomberg Billionaires Index. Two years ago, they numbered 21 and controlled $106 billion, or 3 percent of the combined fortunes.
The biggest gainer in the region this year is China's richest person, Wang Jianlin, who's added $12.4 billion to his fortune. The biggest fall belonges to Robin Li, who's down $2.9 billion.
No fortunes illustrate the whipsaw better than those of Pan Sutong, the Chinese-born chairman of Hong Kong-based conglomerate Goldin Group, and China's richest woman, Zhou Qunfei, chairman of consumer electronics supplier Lens Technology Co Ltd. At the start of the year, Pan had a fortune of $3.7 billion. Goldin Financial Holdings Ltd. and Goldin Properties Holdings Ltd. soared in early 2015, pushing his fortune to more than $25 billion in May. Most of that gain was wiped out a month later. He has $4.0 billion as of July 10.
Zhou's fortune surged with the IPO of Lens Technology in March. In the following two months, the stock rose by more than 500 percent, adding more than $10 billion to her fortune and making her one of China's ten wealthiest people in the process. She lost nearly $5 billion, or close to 40 percent, of her fortune in June.
The roller coaster rides reflect the extent to which the fortunes in the region are tied to volatile public exchanges. The 38 billionaires have 66 percent of their wealth in assets that trade publicly, according to the index. Billionaires in the U.S. and Western Europe have less than half of their fortunes tied directly to public shares, according to data compiled by Bloomberg.
"In a five year scheme, this is just a hiccup,'' Hageback said. "It'll be a dent on a longer-term chart, but it won't be more than that.''
Surging markets increased the value of the biggest fortunes in China and Hong Kong by more than a third in the first half of 2015. And while the July meltdown has eroded more than half of those gains, the 38 richest were by 16 percent year-to-date through Thursday. The 103 richest in Western Europe rose 4 percent in that period and the 127 richest in the U.S. fell 1 percent.
In mainland China it's even more striking. There are 14 Chinese billionaires among the world's 200 richest people with $205 billion combined. Two years ago there were five with $40 billion. The richest in Russia of that group have $173 billion down from $218 billion two years ago. The richest in Germany have remained flat at 15 billionaires with about $174 billion.
It takes an iron stomach to be one of the richest people in China.
Billionaires from China and Hong Kong who rank among the 400 wealthiest people on earth gained $121 billion this year through June 12, 2015, when equity markets peaked there. They lost almost $100 billion as shares plummeted this month, including $30 billion at the start of the week, before the rally on Thursday and Friday.
"I hope these people realize that it's just paper money,'' said Niklas Hageback, who helps oversee about $202 million at Hong Kong-based money management firm Valkyria Kapital. "I hope for their own personal mental health that they have been able to realize that. Otherwise, if you just start to look at your own income statements, the losses are truly horrendous.''
The rise and fall (and potential rise again) has reshuffled the top echelon of global wealth, pushing the world's most-populous country above all others except for the United States in the numbers of billionaires created and the fortunes they control.
There are 26 billionaires from mainland China who have a combined $262 billion, about 6 percent of the $4.1 trillion held by the world's 400 richest people, according to the Bloomberg Billionaires Index. Two years ago, they numbered 21 and controlled $106 billion, or 3 percent of the combined fortunes.
The biggest gainer in the region this year is China's richest person, Wang Jianlin, who's added $12.4 billion to his fortune. The biggest fall belonges to Robin Li, who's down $2.9 billion.
No fortunes illustrate the whipsaw better than those of Pan Sutong, the Chinese-born chairman of Hong Kong-based conglomerate Goldin Group, and China's richest woman, Zhou Qunfei, chairman of consumer electronics supplier Lens
Market Seesaw Reshapes Global Wealth Landscape
Technology Co Ltd. At the start of the year, Pan had a fortune of $3.7 billion. Goldin Financial Holdings Ltd. and Goldin Properties Holdings Ltd. soared in early 2015, pushing his fortune to more than $25 billion in May. Most of that gain was wiped out a month later. He has $4.0 billion as of July 10.
Zhou's fortune surged with the IPO of Lens Technology in March. In the following two months, the stock rose by more than 500 percent, adding more than $10 billion to her fortune and making her one of China's ten wealthiest people in the process. She lost nearly $5 billion, or close to 40 percent, of her fortune in June.
The roller coaster rides reflect the extent to which the fortunes in the region are tied to volatile public exchanges. The 38 billionaires have 66 percent of their wealth in assets that trade publicly, according to the index. Billionaires in the U.S. and Western Europe have less than half of their fortunes tied directly to public shares, according to data compiled by
Bloomberg.
"In a five year scheme, this is just a hiccup,'' Hageback said. "It'll be a dent on a longer-term chart, but it won't be more than that.''
Surging markets increased the value of the biggest fortunes in China and Hong Kong by more than a third in the first half of 2015. And while the July meltdown has eroded more than half of those gains, the 38 richest were by 16 percent year-to-date through Thursday. The 103 richest in Western Europe rose 4 percent in that period and the 127 richest in the U.S. fell 1 percent.
In mainland China it's even more striking. There are 14 Chinese billionaires among the world's 200 richest people with $205 billion combined. Two years ago there were five with $40 billion. The richest in Russia of that group have $173 billion down from $218 billion two years ago. The richest in Germany have remained flat at 15 billionaires with about $174 billion.
Guest Column
What to Watch in Chinese Stock Charts
The swoon in Chinese stocks that shaved 30 percent off the value of the Shanghai Composite Index from June 12 to July 8 has appeared to stabilize. Technical analysis may offer clues as to what may be in store for these markets in the intermediate term.
The Shanghai Composite Index chart at top right shows a good example of an eight-wave Elliott Wave cycle. Wave 1 began in February 2015 with the index around the 3,075 level. We advanced through to Wave 5 which terminated on June 12. We then entered the bearish corrective with Wave A commencing on June 15 and Wave C appearing to conclude on July 8. The chart now shows the early stages of an upward trend in progress, a potential new Wave 1. The chart also shows the 14-period RSI, which turned upward and crossed 30 on July 9, sending a bullish signal.
Finding clues as to whether the recent bullish uptrend constitutes a real reversal of the market requires other analytic techniques. To see if the market state has reversed from bearish to bullish, the lower chart displays the Recognia Probabilistic Market Classifier (PMC) indicator. The Recognia PMC is available as part of the Recognia Adaptive Indicators in the Bloomberg App Store. The indicator uses Bayesian posterior probability to classify the market into one of three states: bullish, bearish or sideways.
In the middle panel of the bottom chart we can see that the eight-period PMC switched from bullish to bearish on June 21. We would look for a switch back to the bullish market state before establishing any new long positions. As further confirmation of the bullish trend, continued upward slope of the RSI is needed.
Click on the chart or run G BBTA 936 for a live version of this chart on the Bloomberg terminal.
Shanghai Composite Index Shows Bearish PMC Indicator
Source: Recognia via Bloomberg
Contact the author for a copy of this chart. To preview Recognia indicators on the Bloomberg App Store go to APP CS:RCOG on the Bloomberg terminal.
Q&A
China Is Getting Close to a Buying Opportunity: UBS
Geoffrey Dennis, head of global emerging market strategy at UBS, speaks with Bloomberg's Tom Keene about what's different with China's equity markets this time around. Comments on this page have been edited and condensed.
Q: Talking to somebody who's seen it before, what is different this time about equity foolishness in China?
A: What's different is that market has
become bigger and bigger in terms of its size in the emerging-market benchmark. The Chinese market today is 25 percent of the emerging benchmark. The impact of these extraordinary gyrations in the local, the Shanghai Composite, the Asia
market then spilled over into the Hong Kong market — or the China market most closely identified with what goes into the emerging market index. It's inflicted pretty heavy losses on emerging market investors. In the past, we haven't really seen that because China was a much smaller market.
Q: The move in China yields isn't that great. Is that because they're a fiction?
A: It's really a reflection that this has been something of a bubble in the local equity market. That's what's been causing all of this. The big run up and then the big pull back — the impact of all of this on the economy is something that we are obviously all debating now. We're not really thinking it's going to be that
important, at least on our current assessment. It seems to be more of an equity market event rather than a fixed income event or indeed a macro event.
Here's a market — the A-Share market, the local market — that went to over 20 times. It got too expensive. There was a
lot of gambling going on in the markets. That's now kind of unwound, and we're still thinking the impact on the economy will not be that great. That could be why you're seeing the fixed income
market basically not reacting much to it.
Q: You said you think the situation is getting pretty close to a buying opportunity. What should people be thinking about buying and why?
A: Bear in mind my focus, is effectively on the China-listed shares in Hong Kong on the Hong Kong China Enterprises Index. That is not the local A-Share market, which not a lot of foreign investors are frankly involved in yet, although more than was the case two, three years ago. The MSCI China Index, the thing that goes into the benchmark keying off the Hong Kong-listed China shares has gone all the way back now to between nine and ten times forward earnings. So it's very, very cheap on conventional earnings metrics. If you do not see much of an impact here on the macro economy, and that's something of course we have to make a judgment on, there really isn't going to be that much of a wealth effect we think on the Chinese economy from this decline. Therefore, you can rely on the corporate earnings numbers broadly holding up. That's why we think it's probably a buying opportunity. Timing it will of course be very hard and the A-share market will have more volatility. But valuations in the internationally held shares in China have come down a long way.
Geoffrey Dennis, head of global emerging market strategy at UBS, speaks with Bloomberg's Tom Keene about what's different with China's equity markets this time around. Comments on this page have been edited and condensed.
Q: Talking to somebody who's seen it before, what is different this time about equity foolishness in China?
A: What's different is that market has
become bigger and bigger in terms of its size in the emerging-market benchmark. The Chinese market today is 25 percent of the emerging benchmark. The impact of these extraordinary gyrations in the local, the Shanghai Composite, the Asia
market then spilled over into the Hong Kong market — or the China market most closely identified with what goes into the emerging market index. It's inflicted pretty heavy losses on emerging market investors. In the past, we haven't really seen that because China was a much
smaller market.
Q: The move in China yields isn't that great. Is that because they're a fiction?
A: It's really a reflection that this has been something of a bubble in the local equity market. That's what's been causing all of this. The big run up and then the big pull back — the impact of all of this on the economy is something that we are obviously all debating now. We're not really thinking it's going to be that
important, at least on our current assessment. It seems to be more of an equity market event rather than a fixed income event or indeed a macro event.
Here's a market — the A-Share market, the local market — that went to over 20 times. It got too expensive. There was a
lot of gambling going on in the markets. That's now kind of unwound, and we're still thinking the impact on the economy will not be that great. That could be why you're seeing the fixed income
market basically not reacting much to it.
Q: You said you think the situation is getting pretty close to a buying opportunity. What should people be
thinking about buying and why?
A: Bear in mind my focus, is effectively on the China-listed shares in Hong Kong on the Hong Kong China Enterprises Index. That is not the local A-Share market, which not a lot of foreign investors are frankly involved in yet, although more than was the case two, three years ago. The MSCI China Index, the thing that goes into the benchmark keying off the Hong Kong-listed China shares has gone all the way back now to between nine and ten times forward earnings. So it's very, very cheap on conventional earnings metrics. If you do not see much of an impact here on the macro economy, and that's something of course we have to make a judgment on, there really isn't going to be that much of a wealth effect we think on the Chinese economy from this decline. Therefore, you can rely on the corporate earnings numbers broadly holding up. That's why we think it's probably a buying opportunity. Timing it will of course be very hard and the A-share market will have more volatility. But valuations in the internationally held shares in China have come down a long way.
Middle Class Urban Households Could Get Spooked: Trusted Sources' Fenby
Jonathan Fenby, founding partner and managing director of the China team at Trusted Sources, spoke to Tom Keene and Michael McKee on July 10 about the Chinese government's next steps.
Q: Is the public in China engaged in the collapse and recovery of their stock market?
A: A fairly thin slice of the public is. It is the urban middle class who have got very engaged in the market. You'll hear figures that there are 90 million people with stock trading accounts in China, but you have to discount that because the Chinese have an awful lot of individual stock accounts. One person may have 10 or 12 accounts. So the actual number involved is much, much smaller than that. And, of
course, this is a huge country. In western China, rural towns and cities with millions of people living there, you'd hardly be hard put to find many stock pickers there.
Q: Will we see further remedial action over the weekend?
A: I think what you'll find over the weekend is probably not actual remedial action steps but an attempt to talk up the market to reassure people that it's all going to be all right. There is the long term aim of the Chinese authorities to use the market for companies to raise money instead of depending on credit and bank loans. And they still want to keep that going, but obviously that reform process is being held back by the turbulence that we've seen in recent weeks.
Q: So few Chinese actually have brokerage accounts and trade stocks. What are we so concerned about?
A: The danger is the Chinese middle class, particularly urban households whose savings are very, very important in China for propping up the property, the real estate market, and for pushing consumption, particularly higher-end consumption, that they will get frightened, that they will hoard their money, put it into the banks, where they've probably got negative interest rates but they'll be looking for somewhere safe. They went into the market expecting quick returns. But if you look at the market in Shanghai, the Asia market, go back to the beginning of last year and even at the depth of the fall this past week in Shanghai, you'd still show a profit of 150 percent during that period.
So it's really there has been a long-term upturn, but it has been the short-term convulsions that have eroded public confidence and could have a knock-on effect on their willingness to spend, their willingness to go into property, all that kind of thing. The 'safety first' reaction would be the broader danger.
Jonathan Fenby, founding partner and managing director of the China team at Trusted Sources, spoke to Tom Keene and Michael McKee on July 10 about the Chinese government's next steps.
Q: Is the public in China engaged in the collapse and recovery of their stock market?
A: A fairly thin slice of the public is. It is the urban middle class who have got very engaged in the market. You'll hear figures that there are 90 million people with stock trading accounts in China, but you have to discount that because the Chinese have an awful lot of individual stock accounts. One person may have 10 or 12 accounts. So the actual number involved is much, much smaller than that. And, of
course, this is a huge country. In western China, rural towns and cities with millions of people living there, you'd hardly be
hard put to find many stock pickers there.
Q: Will we see further remedial action over the weekend?
A: I think what you'll find over the weekend is probably not actual remedial action steps but an attempt to talk up the market to reassure people that it's all going to be all right. There is the long term aim of the Chinese authorities to use the market for companies to raise money instead of depending on credit and bank loans. And they still want to keep that going, but obviously that reform process is being held back by the turbulence that we've seen in recent weeks.
Q: So few Chinese actually have brokerage accounts and trade stocks. What are we so concerned about?
A: The danger is the Chinese middle class, particularly urban households whose savings are very, very important in
China for propping up the property, the real estate market, and for pushing consumption, particularly higher-end consumption, that they will get frightened, that they will hoard their money, put it into the banks, where they've probably got negative interest rates but they'll be looking for somewhere safe. They went into the market expecting quick returns. But if you look at the market in Shanghai, the Asia market, go back to the beginning of last year and even at the depth of the fall this past week in Shanghai, you'd still show a profit of 150 percent during that period.
So it's really there has been a long-term upturn, but it has been the short-term convulsions that have eroded public confidence and could have a knock-on effect on their willingness to spend, their willingness to go into property, all that kind of thing. The 'safety first' reaction would be the broader danger.
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