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Print Edition> Business
UPDATED: July 13, 2015 NO.29 JULY 16, 2015
Rescue Mission Underway

With a raft of supportive measures in place, will China's stock market bottom out amid a continued plunge?

By Zhou Xiaoyan  


Lin Hong, a 28-year-old software engineer, is an amateur stock trader living in Beijing. The three weeks from June 15 to July 3 proved to be a nightmare for him. The market value of the stocks, worth half a million yuan ($80,530) when he bought them, evaporated by 40 percent amid a market slump.

"Since the bullish market started last year, there had been several rounds of minor adjustments. Therefore, when the market first started to decline in mid-June, I thought it was nothing but a new round of minor adjustments. Later, when I realized it was more than that, the regulatory authorities had started to save the market and I pinned high hopes on their policies. Then, when those policies failed to lift the market, stock prices had already slumped and it was too late for me to escape," Lin recalled the three weeks.

"I started trading stocks in 2012, and my earnings from the previous three years have almost been lost," Lin said.

Lin attributed his sobering loss mostly to greediness. "Before the dramatic fall, I had wanted to sell the stocks for many times. But I kept on thinking maybe the price would go even higher tomorrow, and I should wait for another day. That's what got me where I am today."

Lin is just one of the tens of millions of stock traders who have suffered heavy losses, or maybe sleepless nights, over the past few weeks amid a downward spiral in stock prices.

China's A-share market has been on a roller coaster ride over the past six months. The stock market staged a stunning surge from last November to mid-June, when the Shanghai Composite Index (SCI) soared from less than 3,000 points to its peak of 5,166 points on June 12.

To the surprise of many, after the rally, the stock market witnessed its worst three-week loss since 1992. The SCI tumbled by nearly 30 percent in the three weeks from June 15 to July 3. For the Shenzhen Component Index and the ChiNext, the Nasdaq-style board that tracks growth enterprises, the plunges were even deeper. The dramatic fall wiped out $2.36 trillion in the three weeks, more than 10 times the GDP of Greece in 2014.

To avoid further market slide that will endanger the entire financial system, Chinese authorities are doing everything they can to rescue the market. The People's Bank of China (PBC), the country's central bank, has cut interest rates to a record low and pledged to provide ample liquidity for the market; brokerages have committed to buy billions worth of stocks; IPOs have been suspended; state-owned enterprises have been urged to buy more stocks; and major shareholders and senior executives of listed companies have been prohibited from selling stocks in their own firms for at least six months.

Market response

Although the stock market continued to decline from July 6 to 8, a strong recovery was staged on July 9, with the SCI closing at 3,709 points, surging 5.76 percent from the previous trading day and raising high hopes for investors.

Blue-chip stocks responded better to latest supportive measures, with stock prices of some state-owned insurers, banks and oil companies managing to gain sharply, while price recovery was slower in overvalued small stocks.

In the meantime, more companies applied for the suspension of the trading of their shares, in an attempt to create a temporary safe haven from the recent turmoil.

On July 7, another 660 listed companies applied for trading suspensions, which, if granted, will bring the total number of suspensions to 1,420, more than half of the roughly 2,800 companies listed on Shanghai and Shenzhen stock exchanges.

Xu Hongcai, an economist at the China Center for International Economic Exchanges, said China's determination to deal with the situation will help to stabilize the market, but an immediate rebound is unlikely.

"The market will trade in a volatile band between 3,500 to 4,500 points. A buying opportunity is emerging in cheap, large-cap blue chips now, but the small stocks with excessive valuations will continue to decline," he said.

Yang Delong, chief strategic analyst with China Southern Asset Management Co. Ltd., said it's within people's expectations that the ChiNext plunged deeper than the main board.

Price-earnings ratios of some listed startup companies reached as high as 150 times at the peak, similar to valuations seen in the Nasdaq market before the dot-com crash in 2000, he said.

"The ChiNext used to be too frothy. The declining process is a de-leveraging process," he said.

"After the plunge, prices of some ChiNext-listed stocks are quite appealing, and some people are buying at discount. But overall, the ChiNext has more bubble than the main board; therefore, its rebound will come after a rebound in the main board," Yang predicted.

Zhou Yu, an analyst with Pacific Securities Co. Ltd., said the most dangerous deleveraging phase seems to have passed, but aftershocks could still unsettle the market.

"If not effectively managed, it could lead to worsening balance sheets for securities brokerages and banks, creating a 'butterfly effect' in the entire financial system," he warned.

A Chinese investor observes a display screen showing prices of shares at a stock brokerage house in Haikou, capital of south China's Hainan Province, on July 1 (XINHUA)

Why the plunge?

According to Gu Jie, Vice President of Guotai Junan Securities Co. Ltd., poisonous assets--stocks with extremely high valuations--and high leveraging are the main reasons for the current market slump.

It is highly leveraged margin trading--a system that allows investors to borrow money to trade stocks--that prompted a wild rally of 150 percent in the past year until June 12, he said.

On June 12, the China Securities Regulatory Commission (CSRC) announced it would crack down on illegal leveraged trading. The stock market then declined in a chain reaction.

Hong Hao, a managing director and chief strategist at Bank of Communications, also said a rapid decline in margin trading led to the plunge.

If this condition were to continue without government intervention, there would be wider systemic risks, he warned.

Cai Hao, a researcher with Huishang Bank, said institutional flaws have caused the stock crisis.

"A large proportion of the leveraged capital flows to the stock market from Chinese banks, while banks and securities are not administrated by the same regulator, which makes it more difficult to monitor leveraging conditions in the stock market," said Cai. "In the future, the securities regulation system should be improved to allow more coordination between different departments."

After the bubble popped and prices fell drastically, short sellers saw an opportunity to make money from declining stock values by using short futures position, which led to further price declines.

According to Guan Qingyou, Executive Director of Minsheng Securities Co. Ltd.'s Research Institute, the stock market has now been mired in a vicious circle.

"As stock prices decline, many margin trading accounts are compulsorily sold out, which leads to a further decline of prices. A further decline of prices will lead to forced liquidation of more margin accounts," Guan said.

"Without government intervention, the circle can't be broken. The government should take out real money to inject liquidity and buy shares to lift the market," Guan suggested. "When necessary, the market can even be closed to prevent a crash."

"Further steep market declines without government intervention could lead to chain reactions across the financial markets, including the liquidation of fund and trust products as well as rising bad loans in the banking sector. China's decision makers should take this problem seriously as it's about preventing financial risks and maintaining social stability," Guan warned.

Li Kang, chief economist with Xiangcai Securities Co. Ltd., said the government better act quick and fast.

"As a matter of fact, when a stock market crash looms over the horizon, it's quite common for a country to take actions to halt the slide, and that has happened many times in foreign countries," he said.

Restoring investors' confidence is more important than anything. The government shouldn't try to save the market little by little but should be as resolutely as in disaster relief after earthquakes, he said.

"Once the SCI falls below 3,000 points, it will be too late to rescue the market," he said.

More to come

Xiang Weida, a senior researcher with Changcheng Fund Management Co. Ltd., said a massive-scale market stabilization fund should be put in place as soon as possible to restore confidence.

A stabilization fund is a fund set up by the government through certain institutions to carry out reverse operations to stabilize the market--buying in when the market falls sharply and selling out when the market is overheated.

The fund in question, according to Xiang, is a 120-billion-yuan ($20-billion) investment promised by 21 major securities. It is a de facto stabilization fund, meant for exchange traded funds that track the performance of blue chip stocks. This marks the first time such a fund has been established in China.

"However, the size is too small--120 billion yuan is basically nothing compared to the daily turnover of trillions of yuan in China's stock market. To make a difference in the market, the size of a stabilization fund should be no less than 2 trillion yuan ($322 billion)," Xiang suggested.

Li Xunlei, chief economist with Haitong Securities Co. Ltd., said the stamp tax should be lowered to subdue the market slump.

"In history, every time the stamp tax is lowered, the stock market gets a boost," Li Xunlei said.

Lin, the 28-year-old software engineer in Beijing, said he still has hope for the market.

"As long as I have my stocks in hand, I still have hope," he said. "My loss is not real when I haven't sold my stocks."

Lin said a right mindset should be established if one wants to play in the stock market.

"One should never expect to get rich overnight by trading stocks; otherwise, one would be nothing but a desperate gambler," he said.

Before entering the stock market, you should be preoccupied with the notion that even you lose all the investment, your life won't be destroyed. That's when you are ready for the game, Lin said.

Lin said he learned a hard lesson from the past month and would change his investment strategy in the future.

"If the stock market rebounds, I will sell my stocks when a certain amount of profits is secured and gradually reduce investment in stocks," he said. "If the government succeeds in rescuing the market, the bull market will change from a 'crazy bull' to a 'slow bull' and we won't see any drastic increase in stock prices but slow increase. If the government fails to rescue it, the bull market is over."

Looking more bewildered than ever, Lin waits anxiously side by side with tens of millions of investors. But, with a stock crash seemingly inevitable, who knows what will happen to them?

Policy Combo to Stabilize the Plummeting Stock Market

- July 9: Vice Minister of Public Security Meng Qingfeng leads a team to visit the head office of the China Securities Regulatory Commission (CSRC), a sign that the Chinese police have joined the securities regulator to probe clues related to malicious short selling amid recent chaos in the stock market.

- July 8: The People's Bank of China (PBC) says it will provide ample liquidity to help stabilize the stock market. It will work with China Securities Finance Corp. Ltd. (CSF), the state-owned margin lender, to obtain liquidity through loans and bonds. The central bank says it will do whatever it can to prevent systemic risks.

- The CSRC increases the limits for insurers to invest in blue-chip stocks from 5 percent to 10 percent of their total assets.

- The State-owned Assets Supervision and Administration Commission urges the 112 centrally administered state-owned enterprises to buy more stocks of their companies.

- The CSRC prohibits major shareholders and senior executives of listed companies from selling stocks in their own firms for at least six months.

- CSF grants loans of 260 billion yuan ($42 billion) through stock collateral to 21 brokerage firms to allow them to buy more shares.

- The Ministry of Finance encourages state-owned financial firms to increase their holdings in listed companies when prices are at reasonable levels. It also promises not to reduce its holdings in Chinese shares during market volatility.

- July 5: CSF says it will raise funds through multiple channels and expand its business scale to help keep the stock market stable. The PBC will help the CSF to access more liquidity.

- July 4: The 28 Chinese companies that have obtained permission from the CSRC for initial public offerings announce they will postpone the follow-up issue of shares to avoid draining the market liquidity caused by a shares glut.

- China's 21 major securities brokers declare they will spend no less than 120 billion yuan ($20 billion), or 15 percent of their total net assets, on exchange traded funds (ETF) that track the performance of blue-chip stocks.

-July 3: The State Council approves the establishment of a 100-billion-yuan ($16 billion) national insurance investment fund to invest in equities of listed and unlisted companies as well as bonds and equity funds.

- July 2: The CSRC announces it will examine short selling activities for stock index futures, looking specifically for suspected manipulation.

- July 1: The CSRC releases amended rules on margin trading, which relaxes margin trading rules by allowing brokerages and margin investors to decide through discussion when and how large a percentage of additional guarantees should be kept in place as opposed to a compulsory sell-off.

- Shanghai and Shenzhen stock exchanges announce a 30-percent cut on transaction fees to take effect on August 1 to boost the markets.

(Compiled by Beijing Review)

Copyedited by Kylee McIntyre

Comments to zhouxiaoyan@bjreview.com

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