China stocks too far gone to save for Magnus seeing deeper rout

[HONG KONG] Chinese stocks are nowhere near bottoming out, said George Magnus, a senior independent economic adviser to UBS Group AG, who correctly predicted in July the rout would deepen.

Policy makers should stop intervening in the market and allow the Shanghai Composite Index fall to between 2,500 and 2,800, in line with its long-run average, Mr Magnus said. For equities to rally from there, investors need to see improving company profits and evidence that the government is committed to reform, he said. The Shanghai gauge slipped to 3,160.17 on Wednesday, before markets shut for a two-day holiday.

"When the equity market was falling in August, some people said this is a buying opportunity, that this is a multi-year bull market," said Mr Magnus.

"I don't think we will see that unless there is a very significant change in the politics of China. We need to see significant change in the way in which the economy is working and in the way in which the reform is working and both of these things are on the rack at the moment."

The Shanghai Composite has tumbled 39 per cent since June 12, when the gauge reached its highest in more than seven years as mainland investors borrowed record amounts of funds to buy equities. The gains were never justified given the weak growth backdrop, according to Magnus. Analysts expect China's economy to expand 6.9 per cent this year, the slowest pace in 25 years.

From the start of 2010, the Shanghai Composite traded roughly between 2,000 and 3,000 until the end of last year. Now, even after a rout that erased US$5 trillion in value, valuations on mainland bourses are among the highest in the world and dual- listed shares cost more than twice as much on the mainland as in Hong Kong.

In July, Mr Magnus said Chinese equities will extend their retreat by as much as 35 per cent to the 2,500-2,800 trading range. The measure has since fallen 17 per cent.

The Hang Seng China Enterprises Index dropped 1.4 per cent on Friday to close at its lowest level since July 2013.

In an effort to stop to the plunge, China's regulators have banned major shareholders from selling stakes, suspended new listings and asked brokerages to help boost the market. In the latest salvo, the China Financial Futures Exchange on Wednesday moved to limit trading of stock-index futures by lowering the bar for "abnormal trading" and increasing margin requirements and settlement fees. A Caijing magazine reporter was detained for spreading false information, Xinhua News Agency reported last month.

"You've really got to have confidence that they're not going to arrest journalists who spread rumors about the market, to have confidence they are going to allow market forces to some degree influence resource allocation," before stocks can rally, said Mr Magnus. "You've got to have some confidence about openness and transparency and the rule of law."

China's economic policy makers have been just as busy as stock-market regulators, cutting interest rates five times since November and easing bank lending restrictions to bolster growth. An official manufacturing gauge fell to the lowest reading in three years in August, while profits at the nation's industrial companies declined 2.9 per cent in July.

"What we know now is that the rise in the market took place without any reference to what was going on in the economy or to the profits," said Mr Magnus. "I don't see any major risk of reigniting the boom in the equity market."

BLOOMBERG