Soaring Chinese stocks swoon

After a 140% jump in a year, Chinese stocks looked ripe for a correction, defined as a fall of at least 10%. Last week, they got one, suffering their worst five-day period since 2008. The Shanghai Composite index slumped by 13% during last week, and 6.5% last Friday alone. China’s state-backed press saw fit to urge retail investors not to panic. Volatility is normal in equity markets and “all participants should be aware of this”, said the Securities Times.

What the commentators said

The sell-off was so sharp partly because many investors have been buying stocks with borrowed money, said Chao Deng in The Wall Street Journal. So-called margin loans surged to a new record last week. But regulators have been clamping down on the practice to take the heat out of the market. And when stocks slide, investors who borrowed to buy have to sell their other holdings to cover losses, compounding a downdraft. “It’s a vicious cycle,” said Gerry Alfonso of Shenwan Hongyuan Securities.

Investors have also been anticipating a surge in initial public offerings, which would boost the supply of shares in the market. However, this bump seems unlikely to mark the end of the bull market, reckoned BlackRock. “Liquidity and central bank action will probably continue to drive stocks.”

But perhaps not as much as they have so far, said The Wall Street Journal’s Alex Frangos. The government has loosened monetary policy in recent months to prop up growth, and this is starting to have an impact.

The property market has finally “stopped getting much worse” and other indicators, such as industrial production, have “bounced off lows”. The labour market also appears stable. Granted, this is a “tepid” recovery, but the pace of monetary easing could ease from here, weakening a tailwind for stocks.

Even so, with more easing on the cards, and the government keen to help debt-soaked state enterprises raise money from the equity market, “we think it would be premature to call an end to this rally”, said HSBC’s Steve Sun. And longer term there’s scope for further gains as China’s consumers begin flexing their muscles, as MoneyWeek pointed out last week. As the Securities Times put it, “the bullish market logic has not changed yet”.