China puts bull market on life support

“This being China, bull markets aren’t allowed to die without a fight,” says PFP Wealth Management’s Tim Price on his blog.  In the past few days, authorities have redoubled their efforts to prop up China’s stockmarket. After an interest-rate cut and a reduction in the banks’ reserve requirement ratio – allowing them to lend more – stocks continued to slide.

In response, China has suspended initial public offerings to reduce the supply of shares and relaxed the rules on margin trading. Investors may now buy stocks using their houses as collateral. “Not to be outdone,” adds Price, the Asset Management Association of China has tried to cheer people up with a statement entitled, “Beautiful sunlight always comes after wind and rain”. Despite this, the market lost around 25% in just 13 trading days, and only managed a small bounce early this week, then it resumed its slide. The worry is that widespread margin lending, much of which “is off the books, has become a powerful negative force”, says Josh Noble in the Financial Times. Downswings can become self-fulfilling as investors have to sell holdings to cover previous losses that were incurred with borrowed cash.

Easing margin debt rules sounds “mad”, says Deutsche Bank, when you consider that valuations are still “frothy” and domestic shares have still gained 90% since 2013. But the likelihood is that “most investors are in the red”. That’s because peak inflows occurred just before the recent sell-off. The money lost by those who opened 20 million accounts between mid-April and mid-June outweighs the gains made by earlier investors.

More than 80% of investors in domestic Chinese shares are local retail investors, so the market slide has scant impact beyond China. But it has become “a test of strength for Beijing and its state-led model”, says Craig Stephen on marketwatch.com. Having created the boom, they need to be seen to be able to manage the market the way they want. What if the markets stop believing in Beijing’s ability tocontrol lending? wonders Alex Frangos in The Wall Street Journal. Promoting a stock bubble was clearly a “policy mistake”. Making major errors “handling the economy’s deleveraging could prove more devastating”.