PANIC reigned in China and Hong Kong markets on Wednesday as the domino effect of margin calls caused liquidity to dry up on the mainland, and short-sellers pounced in Hong Kong. The fear of contagion swept across Asia. More than a thousand Chinese companies voluntarily chose to suspend trading, and investors are expecting worse to come.
Last night, the Dow was down more than 200 points at 17,574.63 before trading was suspended on the New York Stock Exchange due to a technical glitch.
In China, market participants criticised the way the authorities are trying to prop up stock markets by getting brokers and fund houses to buy stocks. The government should aggressively pursue monetary easing and crack down on the shadow lending sector, they said.
"We could see one to two weeks of selling in China, if we get back to the level of margin loans a year ago," Tan Eng Teck, senior portfolio manager at fund house Nikko AM Asia, told The Business Times over the phone.
Margin debt peaked at 2.3 trillion yuan (S$500 billion) on June 18 and has declined precipitously since then, according to Bloomberg data. Margin debt was at 1.6 trillion yuan on Tuesday, down 30 per cent from the peak.
"Whether the government can stomach this (selling) is another factor. Probably, towards the end of this week or next week, the Chinese can come up with more aggressive monetary measures," Mr Tan said.
He said that the authorities have room to cut bank reserve requirements and interest rates. This will encourage investment and provide liquidity, he said.
China's hitherto red-hot A-share market has corrected more than 30 per cent in less than three weeks.
Over the weekend, the authorities launched a broad sweep of measures aimed at propping it up. Regulator China Securities Regulatory Commission (CSRC) suspended new share listings, and said it planned to increase the capital base of the China Securities Finance Corporation (CSFC), which provides loans for the margin businesses of brokers.
Some 21 large securities brokers said they will pool together 120 billion yuan to buy Chinese blue chips, and said they would not sell their holdings as long as the Shanghai Composite stays below 4,500 points.
On Wednesday, CSRC spokesman Deng Ge said that to restore normal trading conditions in markets, CSFC will maintain stability and increase efforts to buy small and medium-capitalisation stocks.
"CSFC has obtained sufficient liquidity support from the People's Bank of China, and continues to provide securities firms with sufficient funds through multiple channels. Today . . . (CSFC) provided a 260 billion yuan credit line to securities firms' proprietary trading to support stocks," he said on CSRC's website, in Chinese.
Observers told BT the various measures rolled out by Chinese authorities reeked of desperation.
The market might only bottom out after the government becomes the buyer of last resort, said Bank of America strategist David Cui. "Pension funds, mutual funds and insurance companies are not going to have enough buying power," he told BT.
Mr Cui said that brokers are not likely to suffer too much in their official lending business given how margin rules are not lax. But he said one risk is that their proprietary business might suffer losses.
"But the unofficial lending sector is obviously a bit bigger than what most people or the government expected, it could be in the trillions of yuan. Nobody has a complete picture. That's the scary part," he said. "So contagion risk is very high, a lot of assets in China need to be repriced." Mr Cui added that the Shanghai Composite Index is still expensive, at around 30 times earnings excluding banks.
Tan Chin Hwee, an investor who is doing pro bono advisory work for the CSRC and the National Development and Reform Commission, told BT: "Animal spirits should be respected. There are market cycles and it is hard for anyone to regulate flows in the long term." Mr Tan, who also sits on the advisory board of Shanghai Jiao Tong University's Shanghai Advanced Institute of Finance, said China needs to address liquidity risk.
What might disrupt the market further is the rise of peer-to-peer lending fuelled by credit-hungry small and medium-sized enterprises unable to get bank financing, he said.
"With promised annualised returns to investors of 8-18 per cent, Chinese peer-to-peer platforms take the role of underwriters. They are not merely the middlemen of demand and supply for these capital transactions," he said.
Andrew Gillan, head of Asia ex-Japan equities at Henderson Global Investors, told BT he is not rushing to buy China stocks just yet. Mainland-listed A-shares will come under more pressure, while Hong Kong-listed H-shares are more attractively valued, he said.
"We will add to companies that we like, such as (Internet firm) Tencent, if it's sold off significantly with the rest of the market," he said.
China authorities are sending mixed messages to foreign investors by intervening in the market even as it is pushing for stocks to be included in mainstream indices, Mr Gillan added. "The longer term solution is more cultural changes, education that the stock market is risky and you have to take a long term perspective. Maybe talk more about Warren Buffett," he said, referring to the famed investor.
Nikko AM's Mr Tan, who oversees US$2 billion of assets in Asia, 30 per cent of which are in H-shares, said that in the past week, he has been rotating from "market proxy stocks" like insurance companies, brokerages and exchanges into healthcare and tech stocks.
The former group of stocks are highly leveraged and correlated with the market, and will get hit hard as the market goes down, Mr Tan said. The latter will have a stronger structural story in this climate, he said.
"Hospital companies in China are probably the cheapest versus Asia peers now. They historically trade at 30-35 times earnings. Now they are actually in the early 20 times earnings, which is really cheap for hospitals which have generally stable earnings," he said.
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