The rout of the Chinese market after weeks of dizzying climb can scarcely have come as a surprise. Many foreign commentators had been calling it a bubble for quite some time.
While some of the more staid state companies in banking, power generation, etc. never looked especially expensive, the market was driven by absurdly fanciful valuations given to anything which claimed to be high tech, or whose rise was spurred by a bodyguard of hype and misinformation.
But no amount of hype or hope or greed could have taken the market anywhere without weeks of official promotion of the benefits of rising stocks as a way of spurring the economy, and consumer spending in particular, broadening the financial base by shifting from debt to equity funding, and hence improving the position of private against state companies.
President Xi Jinping himself seems to have associated a rising market with the success of his policies, a feel-good factor for the masses to replace the nationalist fervour of the past year which had threatened to undermine China’s influence overseas.
Yet all this official approval reflected in statements from the China Securities Regulatory Commission, Xinhua and other top level state sources would have created a stock boom without the surge in margin financing provided by brokers who in turn were being funded with official approval by the state banks.
Such high levels of margin finance were particularly dangerous given that the Chinese market is dominated by small investors most of whom are new to the investment game. It is easy not to panic when using your own money, not so easy when you have borrowed most of your investment and thus stand vulnerable to you or your broker being wiped out.
It was entirely rational that leveraged punters would make a dash for the exits once the market appeared to have turned. Briefly some stopped in the hope that the almighty government would come to the aid of the market. Beijing’s desperation is reflected in an extraordinary move over the weekend, dragooning major brokers and fund managers into collectively pledging to invest at least $19 billion of their own money into the country’s flailing stock markets amid fears that a meltdown would rock the financial system and inflict heavy losses on an already flagging economy.
But so far the power of the market has proved bigger even than that of the combined forces of the Communist party, the banks and the state agencies. Announcements supposed to prop up the market –a search for “cross-market speculators,” western short-sellers – a slowdown in new issues, monetary easing, have had nothing more than a very short term impact.
Naturally a government that has so associated itself with the market climb now must look for scapegoats. The recently unveiled new Chinese National Security Law is so wide and so vague that almost anything can be deemed contrary to it – eg those who short stocks or bad-mouth companies.
Almost needless to say given the chauvinism which is the bedrock of the party and state agencies, a leading culprit was foreigners. They were trying to suppress the rise of China, hoping its capital market-led reform would fail, etc etc. US house Morgan Stanley was singled out for attack for issuing a sell recommendation on China stocks. In December Morgan Stanley had recommended buying China, a good call at the time so it was more than reasonable to advise profit-taking after six months of gain.
Foreigners play a miniscule role in the China market and most of that is hemmed in by regulatory issues. But almost any excuse was needed to cover up not just the mistakes of the government but the belief among many losing investors that the market was manipulated by well-placed locals who pumped up certain stocks then bailed out once the ignorant crowd started to buy in.
This kind of manipulation has long been common practice in developing markets as an older generation of investors in Malaysia, Hong Kong, etc will remember. The problem for China is that such persons are also assumed to be well connected to the party if not the government. Given the fears of being targeted in anti-corruption drives, party members now realize it is much easier to make a few tens of millions by being a market insider or board member of a listing company than taking kickbacks on property deals.
Foreigners also mainly focus on the better known counters, some of which have Hong Kong as well as Shanghai listings. The boom and bust was mostly focused on lesser counters, the two thirds of the market which has fallen 40 percent from their peak, with tech-focused Shenzhen suffering most, than the Shanghai A index which is down 28% from its June high of 5,423 but still up 80% since August 2014.
Apart from foreigners, the alleged manipulators are those who have been shorting either individual stocks or the market. In practice, shorting is difficult, limited and has to be reported in detail. It is mostly been practiced by institutions which wanted to lock in profits or otherwise hedge as the market rose. Again shorting is a necessary part of an efficient market and acts as a counter to bursts of euphoria. If it were easier in China it could have tempered the run-up.
Official efforts to prevent the market falling further in the short term may well succeed but millions of punters have learned a lesson which they will not quickly forget. But whether the government has learned much is another matter as it attempts to square a circle – the quest for open capital markets with the position of a party whose priorities is itself and its weapon is nationalism.
It seems unlikely that a return to euphoria can be engineered, meanwhile the pressure for new listings will not go away. Not only is this part of state policy but listings enable board members and party officials to make fortunes at public expense but in a manner which is not technically illegal. Recent events – and outbursts of chauvinism – will dampen foreign enthusiasm for China stocks. A period of relative quiet and downward drift looks the most probable follow-up to recent gyrations.