The one thing China’s bulls and bears can agree on is that swings in the world’s most-volatile major stock market are only going to get bigger after equity traders took on record amounts of debt.
Both Bank of America Corp. strategist David Cui, who predicts Chinese shares will fall, and JPMorgan Chase & Co.’s Adrian Mowat, who has an overweight rating, say the surge in margin lending to all-time highs is amplifying price fluctuations in the $4.9 trillion market. Volatility in the benchmark Shanghai Composite Index reached the highest level since 2009 this week after rising more than fourfold since July.
While the flood of borrowed money into Chinese stocks added fuel to a 59 percent rally in the Shanghai Composite during the past 12 months through yesterday, the
gauge’s 7.7 percent tumble on Monday illustrates how leverage can also accelerate declines. Margin traders unloaded shares at the fastest pace in 19 months during the rout, which was sparked by regulatory efforts to cool the growth of margin debt in a market where individuals drive 80 percent of equity volumes.
“Margin trading will add more up-and-down to the market and increase volatility,” Xie Weiyu, a strategist at Shenyin & Wanguo Securities Co. in Shanghai, said in a Jan. 12 e-mail. “If a correction starts, the magnitude will be bigger than the past few years.”
CSRC Curbs
In a margin trade, investors use their own money for just a portion of their stock purchase, borrowing the rest from a brokerage. The loans are backed by the investors’ equity holdings, meaning they may be forced to sell when prices fall to repay their debt.The Shanghai Composite sank the most in six years on Monday after the China (SHCOMP) Securities Regulatory Commission suspended the nation’s two biggest brokerages from lending money to new equity-trading clients and said securities firms shouldn’t lend to investors with assets below 500,000 yuan ($80,467).
Outstanding margin loans on both the Shanghai and Shenzhen exchanges surged more than tenfold in the past two years to a record 1.1 trillion yuan as of Jan. 16, or about 3.5 percent of the nation’s market value. On the New York Stock Exchange, margin debt amounts to about 2.1 percent of market cap on the NYSE Composite Index.
Margin lending is a “new phenomenon in China,” said Cui, who anticipates the Shanghai Composite will fall about 5 percent by year-end. “When the tide turns, it’s going to be very ugly, because you will have a forced exit from the market.”
Volatility Jump
A gauge of 30-day volatility on the Shanghai Composite rose to 42.3 on Jan. 19, the highest among the 15 biggest global benchmark indexes tracked by Bloomberg and up from its decade-low 9.4 in July. Daily turnover on China’s exchanges reached a record 1.24 trillion last month, when the Shanghai stock measure surged 21 percent.Monday’s tumble followed a string of big moves in Chinese stocks during the past two months. The Shanghai Composite surged 4.3 percent on Dec. 4 after mainland investors opened new stock accounts at the fastest pace in three years. The stock gauge plunged 5.4 percent on Dec. 9 as authorities tightened collateral rules for short-term loans in the nation’s repo market.
The CSRC on Jan. 16 banned Citic Securities Co. (600030), Haitong Securities Co. and Guotai Junan Securities Co. from adding margin-finance and securities lending accounts for three months, following rule violations.
Artificial Liquidity
“In the short term, we’ve got an extremely fast and sharp move and there’s some leverage in play which is not good quality,” said David Gaud, a Hong Kong-based money manager at Edmond de Rothschild Group, which oversees about $158 billion. “For long-term investors, this is a worry. It disturbs and disrupts the picture of liquidity which is artificial and may disappear overnight.”The Shanghai Composite rebounded 1.8 percent Tuesday after economic data beat estimates and the CSRC said the measures aren’t designed to curb equities trading. The securities regulator said it will help support the “healthy growth” of margin financing.
The stock index surged 4.7 percent today, its biggest gain since October 2009, while a gauge of 10-day volatility jumped to its highest level in six years.
For JPMorgan’s Mowat, the increase in margin debt poses little risk to China’s financial system because the shares backing the loans can be easily sold to repay creditors. His bull case for China’s mainland shares is predicated on the prospect that local individuals will increase their equity allocations amid looser monetary policy and a slowing property market.
“Margin lending increases the impact of cash flow,” Mowat, the head of Asian equity research at JPMorgan, said in a Jan. 7 interview. “As the market goes up, it can accelerate movements.”
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