The China Equity Market Syndrome Is Bubbling Up

It was only yesterday that I pointed out that central banks ( Riksbank and the Bank of England) were starting to publicly admit to worries about Greece. The logic here is that some form of default would upset the world’s financial system via contagion effects. However something potentially much more systemically important is happening in the Far East to no fanfare and indeed not much attention. There have been many column inches devoted to the concept and possibility/probability of financial bubbles building in China but so far much fewer about the reality of one showing signs of bursting.

Regulatory Action

One sign of turmoil and official concern is action by regulators and my attention was drawn to this from earlier today. From the South China Morning Post.

the China Securities Regulatory Commission (CSRC) has set up a team to look at “clues of illegal manipulation across markets”.

Let us move to the China Daily which broke the news to us westerners at least.

The country’s securities watchdog announced late Thursday it will investigate suspected manipulation of the stock market as experts fail to explain worst collapse in years.

Zhang Xiaojun of the China Securities Regulatory Commission (CSRC), said the investigationwill focus on such activities occurring simultaneously in multiple markets. The CSRC has tracked irregularities between securities and futures trading.

The CSRC will transfer any criminal cases to the police, Zhang said.

Have you noticed that the regulator the CSRC only seems to have got interested when the equity market has had the “worst collapse in years”? The bubbilicious surge which preceded this decline never bothered it like this! Such behaviour concerns our suspicion that as far as equity markets are concerned the official view virtually everywhere is to sing along with Yazz.

The only way is up, baby
For you and me, baby
The only way is up
For you and me

Margin Trading

A feature of such problems is the advent and then increase in the amount of margin trading – where trading is financed by borrowed money – which the CSRC implicitly confirmed earlier this week when it did this. From the South China Morning Post.

The CSRC has also relaxed rules on using borrowed money to speculate on stock markets, letting brokerages set their own tolerance level on margin calls and allowing the roll-over of margin lending contracts.

This may be behind the sharp rally on Tuesday although phases like this do experience sharp short-covering rallies which are known by the unpleasant phrase “dead cat bounces”. The more a market depends on borrowed money or margin trading the more likely these become as things become more tightly wired and vulnerable. Reuters puts it thus below.

Much of the selling of Chinese stocks has been driven by “margin calls”, when a brokerage that has extended credit to an investor to buy stocks demands more cash or collateral because prices have fallen.

The official attempts to stop this are looking increasingly desperate. From Bloomberg.

Under new rules announced Wednesday by the country’s securities regulator, real estate has become an acceptable form of collateral for Chinese margin traders, who borrow money from securities firms to amplify their wagers on equities.

So you can finance the equity bubble from the property bubble! What could go wrong?

Paranoia Alert

I think that this from the South China Morning Post is rather extraordinary even for China.

Were foreign puppet-masters really behind the tanking Chinese stock market?

It echoes some imagery from the later Dune novels and there is more.

In a cartoon published on Tuesday by thepaper.cn, a state-owned digital media outlet that aims to engage with a young audience, an old Chinese woman is depicted as saying she wants to thank the government for helping to rescue the market. She also blames “foreign ghosts” for willing it to crash.

The cartoon immediately went viral on Weibo and WeChat, China’s two most popular social media networks.

Of course China would be far from the first country to make scapegoats of foreigners.

Actually the cause may be much nearer to home

On the lines of what goes up (especially at that rate) must come down I was interested to see this from J Capital Research in the Financial Times.

The sucking sound you hear is the average person’s bank account being drawn off into the hands of the red elite. Stay tuned, but maintain a safe distance.

Indeed the elites seem to have been behaving rather like the evil capitalist imperialists.

Ultimately, market participants all understand that the A-share bubble has been engineered to distract the average person from sinking values and illiquidity in the property markets. The pools of cash owned by Chinese people are regularly redirected to the asset classes that the government needs to rise and that elites are tapped into,

An interesting view of what is perceived to be capitalism but is really just another version of central planning.

Moving from the financial to the real economy

Iron Ore

This is another market which has been affected by margin trading and we should not be surprised that it has been unsettled by events if we recall how big a player China is in it. From Reuters.

China uses more than a billion tonnes of iron ore a year to make steel – 14 times the consumption of the United States

That is an extraordinary number is it not? Well perhaps traders are mulling it now.

the price of the raw material fell by 5 percent.

Iron ore delivered to China .IO62-CNI=SI stood at $55.80 a tonne, its weakest since late April,

This gives us link to the real economy as we know that the overall trend for Iron Ore prices have put Iron Ore solidly into a bear market. There is an implication here for the underlying strength of the Chinese economy and also for the western end of the South China Territories (Australia).

Monetary policy hints at fears for the real economy

This situation is one where the Chinese economy is plainly showing signs of slowing and what it does not need is what is happening in its equity markets. We have seen a variety of easing moves by the People’s Bank of China in 2015 with the latest interest-rate cut coming as recently as last Saturday.

The problem is a familiar one to the Greek crisis and it is that when there are worries about solvency providing liquidity and lowering interest-rates help little. If you have to pay 1% per annum less it does not help a lot if you have investments which have just lost more than 20% over the past three weeks. The situation gets worse by an order of magnitude each time the investor has geared the position by borrowing funds.

Comment

On the surface it may seem that there is little to worry about here. After all the Chinese stock market has rallied strongly and indeed more than doubled since last summer. But the catch is that the ordinary or retail investor only tends to get in on the tail end of such moves and of course any margin trading is especially vulnerable to declines and bear markets. There will be cross currents from other struggling markets like Iron Ore for institutional traders and for the ordinary person from the troubles in the property market.

Accordingly as we stand right now it looks as though the Chinese elite did not learn much at all from the problems of the evil capitalist imperialists. If they also slam into a credit crunch then on a world scale it will have much more impact than what is happening in Greece.

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21 thoughts on “The China Equity Market Syndrome Is Bubbling Up

    • Hi Andy Z

      I did think of them as I was writing the piece but did not realise that was the title of their second album. I guess much of what is going on in Chinese official policy right now is an example of what was apparently song number 6.

  1. Hi Shaun
    Umbella Trusts and P2P sites feeding the Chinese insatiable desire to gamble.
    China collapsed the time period for ‘boom’ from century to decade; now it looks like its going for ‘bust’ in years rather than decades. This particular can kicking by the Politburo is going to end very nastily.

    • Hi JW

      Yes event half-lives have indeed sped up which is another feature of these times. The list of short selling bans which have worked is a lot shorter than the ones where it hasn’t so the Chinese are currently heading down a dead end.

      For the rest of us it means more QE I think and it to cover more assets. The ECB ticked that box rather nicely earlier this week. To Infinity and Beyond fits not at all well with shorter half-lives…

  2. the China Securities Regulatory Commission (CSRC) has set up a team to look at “clues of illegal manipulation across markets”.

    I won’t be holding my breath for the arrest of all of the Government officials that report the ‘official’ economic growth rates!

    The Chinese economy reminds me of Greek spinning plates, when too many are in the air and the person trying to keep them spinning is fighting a losing battle as more fall to the ground.

    It will be interesting to see if the Chinese officials manage to engineer a soft economic landing. Personally, I think it is unlikely and the more spinning plates they use to try and keep it airborne the bigger the crash will be when it arrives.

    • Hi Rods

      I remember a past boss of mine (hello Rupert if you are out there…) one of whose favourite sayings was “insider trading only became illegal when it was no longer the sole preserve of the establishment”. In these times that theme is impossible to argue with I think.

      As for China as you say it has ever more plates in the air which requires ever more skill and frankly now,quite a bit of luck.

      • Excellent saying.

        Interesting report by the Brookings Institute on what has gone wrong with US capitalism and IMO to a slightly lesser extent the UK. It is basically public companies ‘pleasing and managing’ their management and shareholder earnings every quarter at the expense of investment, employees and customers for short term gain but long term underperformance.

        http://www.brookings.edu/~/media/research/files/papers/2015/06/30-american-economy-growth-strategy-galston-kamarck/cepmglastonkarmarck4.pdf

        Now a definite trend and problem has been identified, will the politicians do anything about it?

        • Indeed.
          One obvious way in which the business/customer relationship has changed, is the way long-term relationships are viewed.
          What was once seen as “customer loyalty” a nurturing of long-term relationships for the long-term good of both parties, is now seen as “customer inertia” to be ruthlessly exploited.
          There are new-customer-only deals, which undercut the price that previous customers pay, everywhere.
          For example, each year the AA tries to charge me £60 more for services than for a newcomer.
          I now deliberately avoid brand loyalty.

        • Whilst there are some new causes cited for this trend, I am afraid it is a trend which has been around and known of in the Uk for at least 40 years, so given the politicians have done zero about it in that time, other than to encourage it with the arrival of “big bang” in the 80’s, I see no reason why the politicians will do anything about it now.

  3. I am afraid that I have now come to the overwhelming conclusion, after long observation, that you are in fact a “Yes man”, and that you in general tow to the establishment and MSM line of deception in the present scenario. It is understandable that they do this, but if you try to pretend that you are not a “Yes man” why do you do it? You had better re-name your blog to “a convinced Yes man economics blog”.

    • I disagree, where Shaun’s take on many things are very different to the MSM and I personally think with his presentation of many useful economic facts, good supporting arguments, many of which are certainly not mainstream, that his blog is an invaluable resource and the economic blogosphere is the much better for it.

    • Thanks for that Merv.Slagging off poor old Shaun isn’t going to change the fact that you helped create the crisis and still failed to see it coming.

      In fact,nothing ever will.Glad I could help.

    • Hi Drf, Everyone’s entitled to their opinion but that’s a bit harsh isn’t it? As a keen follower of news and current affairs I observe most of Shaun’s output is not regurgitation of the MSM’s line. I would argue that Shaun is often ‘ahead of the curve’ with his analysis that sometimes in the end the MSM give coverage to as well as certain facts become undeniable. Look at his take on forward guidance as one example. No one else was saying a cut was as likely as a rise a year ago from what I recall and yet the predicted rate rise hasn’t happened and a cut? Well, that seems to be the way it’s heading.

      • “predicted rate rise hasn’t happened and a cut? Well, that seems to be the way it’s heading.” – once more into the fray I will stick my neck out and say I disagree with you and Shaun on this – it’s unlikely, although not impossible but I will be surprised if the UK hits zero rate.

    • These comments are embarrassing. I have never read such bilge. You might at least have had the wit to cite some examples to bear out your position.

      Almost all of Shaun’s economic predictions have come to pass, or at least heading in his direction. How many other commentators have been so excoriating on say the BoE, the MPC and particularly it’s individual members? Who else railed against first Governor King and his blind eye on inflation (except for the BoE Pension scheme), then later at Carney’s silly Forward Guidance?

      Who else in the MSM called the EFSF/ESM an “unstable lifeboat” nearly four years ago? Who else has been ripping the ECB to pieces?

      Who else has antagonised the Royal Statistical Society such that it is going to change a metric of inflation?

      Clearly I could go on. Suffice to say can I kindly suggest you get a basic grip on comprehension before contributing, it will save you embarrassing yourself in future.

      AZ

      • Formatting… comments above aimed squarely at drf not the other replies above. Apols for any confusion.

    • Hi Cooking The Books and welcome to my corner of the web

      Thanks for the link which shows that the Chinese can copy the evil capitalist imperialists at times! However these sort of moves rarely work and in fact often make things worse. After all imagine if you wanted to sell shares in the suspended companies how would you be left feeling?

  4. When they talk about history repeating itself, first as tragedy then as farce, this Chinese market manipulation it reminiscent of the 1929 wall street crash. Then as now big firms shouted publicly about buying blue chip stocks, and how safe the market was. Then as now there was small rallies, before bigger and bigger falls. This along with Greece could indeed be the financial Armageddon that we’ve all been waiting for, since the start of the credit crunch. Meanwhile here in merry Olde England (or UK for that matter) we have continued to insure that the next generation is more indebted than every before, via helping to keep house prices raising or the push for further education being the key to monetary harmony as long as we take out bigger and bigger student loans, overdrafts and credit cards to fund this nirvana.

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