A dodgy move by China's central bank

China's central bank has sent a clear signal that it is prepared to stand behind stock buyers.

"For thrills and spills, you cannot beat Chinese share markets," says Ralph Atkins in the Financial Times.In the 12 months to 12 June, the Shanghai Composite index more than doubled. Since then, it has slumped by more than 20% a bear market. Last Friday it slumped by around 7%, and on Monday it fell further despite central bank action over the weekend. The People's Bank of China cut interest rates and trimmed reserve requirements for banks, freeing up cash for them to lend. On Tuesday stocks rebounded.

Stocks are still expensive, says Aaron Back in The Wall Street Journal. They trade on around 19 times forward earnings while the median stock is on 44 times, due to soaring small and mid-cap stocks. So "the market has plenty of room to fall". Unlike when the last equity bubble burst in 2007-2008, this time "it won't be only Chinese stock gamblers who feel the effects".

The problem is not down to rattled investors spending less because they feel poorer, says Back less than 10% of households own stocks, compared to 50% in the US, where the "wealth effect" is much more pronounced. But the Chinese stock boom has given brokerages and trading firms a hefty boost, propping up a lacklustre economy.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free
https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Another problem is that so many people have borrowed money to invest. Margin debt is worth 12% of free-float market capitalisation and 3.5% of GDP. These figures, says Goldman Sachs, are "easily the highest in the history of global equity markets". And they cover just the regulated brokers. A wave of defaults related to stockmarket losses could have knock-on effects throughout the financial system.

While China's central bank "would never admit" it was trying to bolster stocks, it's hard to believe this loosening was a coincidence, says Nils Pratley inThe Guardian. But it looked "panicked" shares are still up by around 33% since January, after all. And it's a lose-lose manoeuvre, adds Breakingviews's John Foley.

If the market now recovers, the authorities "will have sent a signal that they are prepared to flex their monetary principles to save stock buyers". That could fuel speculation and reflate the bubble. But if the market keeps slipping, "so might faith in China's policymakers to influence [other] markets". China remains a promising long-term bet, but for the government managing the downturn has just become more complicated.

Andrew Van Sickle
Editor, MoneyWeek

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.