How US$3 Trillion Disappeared From The China Stock Market

Move aside Greece. For us in Singapore, the sudden burst of the China Stock Market bubble is something that is hitting us a lot closer. After soaring to a peak of 5,166.35 on 12th June, the Shanghai Composite Index has plunged 32.11% in less than a month, striking fear that it may lead to further repercussions such as the slowing down of the China’s economy.

That being said, let us take a closer look at what has actually happen.

Various push factors in place

The rally started to gain steam from last November, when the People’s Bank Of China (PBOC), which is the central bank of China, began cutting interest rates and bank reserve requirements (RRR). While the easing was intended to support growth and liquidity, which had dried up due to an increased of capital outflows, market participants took this as a cue of the government’s intention to support the expansion of the equity market.

A switch by people from property investment to stock investment also fueled the rise of the equity market. Laws liberalising the stock market also made it easier for funds to invest and for firms to even offer shares to the public for the first time.

The stock market boom in China was largely driven by the participation of retail investors. During the past twelve months, the number of individual investor accounts rose 24% from 93 million to 115 million in the Shanghai stock exchange, and 26% from 113 million to 142 million in the Shenzhen stock exchange.

A surge in margin lending also allowed retail investors to leverage up to many times their capital, which ultimately also led to their downfall.

Too fast, too furious

The Shanghai Stock Exchange Composite index (SHCOMP) rose 150% for the 12 months leading up to 12 June 2015. The rally, however, wasn’t based on any material upswing in economic fundamentals. Instead, over this period, the economy actually slowed down, with both exports and domestic demand weakening, as did corporate profits. Capital outflows increased inspite of the high trade surpluses. The balance of payments turned negative for two consecutive quarters.

Despite these signs, the authorities continued to guide public expectations towards lower to medium-term growth as they had done over the past two years.

The rally finally peaked on 12 June. Initially the correction was driven by high valuations plus the accelerated pace of IPOs being launched. The market feared that the monetary easing would slow down and that there will be a tightening of rules on margin financing. Subsequently, the correction intensified, as policy measures were seen as inadequate or ill targeted.

Government Intervention

Since then, the China government has stepped in and released a slew of stock market stabilization measures including the purchase of shares and the easing of margin-lending rules, some of which are highlighted below:

27 Jun: PBOC PBOC announced to cut benchmark interest rates by 25bp, effective June 28. PBOC also announced targeted RRR cuts.

29 Jun: A drafting proposal that will allow national pension fund to invest in the equities market. This allow for a maximum of about 1 trillion yuan investment in the stock market, which was released and circulated for market feedback.

2 July:
(a) Shanghai and Shenzhen Stock Exchanges reduce transaction costs by 30%;
(b) CSRC abolished mandatory requirement on margin calls and liquidation for margin loans;
(c) broaden financing channels for brokers

8 July:
(i) SASAC requests SOEs not to cut shareholdings, and supports SOEs to increase holdings of undervalued shares.
(ii) China Securities Finance Corporation Limited (CSFC) provides 260 billion yuan credit to brokers
(iii) CSRC encourages major shareholders of listed companies to raise their shareholdings

9 July: CBRC announced that banks could adjust loans terms with stock collaterals; encouraged banks to offer financing to China Securities Finance Corporation Limited (CSFC) via interbank co-operation and financing

What’s next?

While the Chinese stock market appears to have calm down during the past few trading sessions, it is important to remember that over 40% of listed stocks are currently suspended. That means the true reflection of market sentiments is not known yet, and that one has to wait and see how the market reacts to the resumption of trading.

Ultimately, how the equity market behaves will depend on the confidence of market participants. And this is hard to prejudge. Needless to say, the situation requires close monitoring, particularly if it were to spillover into other countries.

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