The World’s Wildest Stock Market Submits to Communist Party Rule

by Kyoungwha Kim

 

It took three weeks of unprecedented government intervention, but Chinese authorities have finally managed to subdue the world’s wildest stock market.

That’s the verdict from options traders, whose expectations of share-price swings on mainland exchanges have tumbled 48 percent since the end of June. In a market where daily fluctuations exceeding 3 percent had become the norm, this week’s moves of less than 1 percent in the Shanghai Composite Index have barely registered on the price charts.
For bulls, the growing sense of calm is a key step toward restoring investor confidence after the Shanghai Composite lost as much as 32 percent from its June high. Bears point to the costs of intervention, including an exodus by international money managers and the moral hazard of backstopping one of the world’s most expensive stock markets.
“The government has won the battle in terms of stemming the rout, but they’ve lost the war if you think of the bigger picture,” Megan Greene, the chief economist at Manulife Asset Management, whose parent company oversees about $648 billion worldwide, said in a Bloomberg Television interview in London.
China’s ruling Communist Party has gone to extreme lengths to tame the nation’s $7.2 trillion equity market. Officials allowed more than 1,400 companies to halt trading, banned major shareholders from selling stakes, suspended initial public offerings and gave a government agency access to more than $480 billion of borrowed funds to help finance equity purchases.

State Intervention

Options traders have responded by pushing down the cost of contracts on the China 50 ETF, which tracks some of the country’s biggest companies. Implied volatility on the derivatives, a key gauge of prices, has dropped to the lowest level since the start of June. The Shanghai Composite’s 10-day historical volatility, meanwhile, has almost halved from its July 10 peak.
The government’s aim “is to stabilize the market, which they have achieved,” said Nick Cheng, the chief derivatives trader at Liquid Capital Markets Ltd. in Hong Kong.
For overseas money managers, China’s intervention has cast doubt on the government’s pledge to enact the free-market reforms needed to make mainland shares eligible for MSCI Inc.’s global indexes. International investors have been net sellers of yuan-denominated A shares via the Shanghai-Hong Kong exchange for 11 of the past 12 days.

Margin Debt

“Most foreign investors are scared and stunned,” said Warut Siwasariyanon, the head of research at Asia Wealth Securities Co. in Bangkok. “It’s unlikely that there will be another major rally.”
Still, the Shanghai Composite has gained 15 percent from its July 8 nadir, making it the world’s best-performing benchmark equity index during the period. Share-price targets compiled by Bloomberg imply another 16 percent upside over the next 12 months.
“The worst is over,” said Stephen Yang, the head of institutional research at Sun Hung Kai Financial Ltd. in Hong Kong.
Intervention also buys time for policy makers to put the market on more solid footing by reducing the use of unregulated margin trading, according to Chen Gang, the chief investment officer at Shanghai Heqi Tongyi Asset Management Co.

Moral Hazard

Authorities tightened control over online financing last weekend, applying more oversight to an industry that helps funnel borrowed money into the stock market. The websites offered 3.1 billion yuan ($499 million) of new loans for equity investment in May, up about sixfold from January, according to the Yingcan Group, which tracks peer-to-peer finance platforms.
For Francis Cheung, the head of China and Hong Kong strategy at CLSA Ltd., government intervention creates moral hazard because investors will expect a rescue whenever share prices sink. The risk is especially acute in China because equity valuations outside the banking sector are already expensive, he said.
At 69, the median trailing price-to-earnings ratio on mainland bourses is higher than in any of the world’s 10 largest markets. It was 68 at the peak of China’s equity bubble in 2007, according to data compiled by Bloomberg.
“At the end of the day, they want a real functioning stock market, which means valuations cannot really be at such an elevated level,” Cheung said in an interview on Bloomberg Television in Hong Kong.