Has the dragon run out of puff?

31 Jul 2015

By Shadforth Financial Group

​As Chinese property lost momentum in 2014, retail investors shifted their money to the stock market, spurred on by state government publications. China A shares are mainland-based, denominated in yuan and traded primarily by locals on the Shanghai and Shenzhen stock exchanges.

A phenomenal rally in China A shares began in July last year, fuelled by many first time retail investors gripped by stock market fever. More than 40 million new trading accounts were opened in the first five months of 2015 and the value of outstanding margin loans (where brokers lend money to investors to purchase shares) had increased more than fivefold over the previous year to 2.2 trillion yuan (AU $473 billion).

The Shanghai stock market reached a seven year high on 12 June, having gained 152% over the preceding 12 months. Investors expected the People's Bank of China (PBoC) to provide further stimulus, action to which they had become accustomed through the Beijing engineered rally.

The PBoC failed to act and the market slid 2 per cent. A flood of IPOs hit the market the following day, just as sentiment was beginning to falter. Investors eager to gain a piece of the action sold existing shares and leveraged investors began getting margin calls. Panic set in and the sell-off gained pace. Retail investors account for around 85 per cent of share trade in China, unlike major global stock markets which are dominated by professional investment managers, exacerbating the volatility. By 8 July the market had plunged 32 per cent from its recent high.

As the market tumbled, the Chinese government started undertaking a series of actions in an effort to stop the carnage. The measures began with injections of liquidity and interest rate cuts before escalating to more extreme measures including indefinitely postponing 28 planned IPOs and halting trade in 89 per cent of shares listed in mainland China.

The 'kitchen sink' approach adopted by the Chinese government appears to be halting the fall. At the time of writing, the Shanghai composite index had recovered 11 per cent from its lows. However, the moves by the Chinese government raise questions over the government's commitment to economic reform and liberalisation of the capital markets.

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