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China may champion market forces for currency, but don't expect that for its stock market


Retail investors with little formal education are likely to have suffered the most from the recent plunge in China’s stock market, creating a political problem for policymakers that will likely ensure abnormal policies to support the market will remain in place for some time yet.

That’s the view offered by the NAB in a research note released earlier today in which they note that close to 90% of the 60 million accounts created to trade Chinese A-shares in Shanghai and Shenzhen were done so by investors with less than 100,000 yuan to invest.

“No less than 27 million new individual investor accounts were opened for A share market investors on the Shanghai exchange between March and July with another 33 million at the Shenzhen market”, says the NAB, adding “CSDC data shows almost 90% of the growth in investor numbers involved accounts of under RMB100K”.

They also note that “a late 2014 China Household Finance Survey also found that the majority of new investors in China’s equity markets had little formal education, with only one-third having completed high school”.

That’s 40 million stock trading accounts – four with seven zeros following it – that were opened by investors who had failed to complete high school.

Many, as has been well documented, were also leveraging to amplify expected market gains.

According to the NAB “transactions involving margins increased during the equity boom, reaching 3 or 4% of market capitalisation (higher than the New York Stock Exchange), before falling sharply as the bubble bust. They suggest that with many shares unavailable to trade, the proportion of transactions using leverage as a proportion of China’s “free float” market capitalisation was probably close to double the 3 to 4% level stated.

Using data from the China securities finance corporation (CSFC), a state-run body that provides financing to securities brokers that can be then onlent to investors, the NAB estimate that at the market’s peak, lending for margin financing could have been as great as 3.5 to 4.0 trillion yuan – nearly a third of all money lent in China’s residential housing market.

These are huge numbers, particularly when you consider the concern there is over the levels of debt in the Chinese property market.

While the benchmark Shanghai Composite index did rally by an impressive 57% from the start of March until June 12, from the peak of 5,178 struck on that day, the index has subsequently fallen by close to 24%.

It’s a safe bet that many who opened accounts between March to July have, for the moment, suffered substantial capital losses, particularly those who bought towards the end of the rally using leverage.

The decline is seen as a particularly awkward scenario for Chinese policymakers according to the NAB.

“The burst equity bubble is particularly awkward for the Chinese authorities as official media outlets and spokesman were seen as having talked the market up. Back in 2014 the State news agency was calling for a “quality bull market”, an April 2015 opinion piece in the People’s Daily said that the Shanghai index of 4000 then prevailing was just the start of the bull market and the head of the securities regulatory agency said he applauded the concept of a “reform bull market” and that higher equity prices had some reasonableness and inevitability”.

Given this has failed to materialise – the Shanghai Composite is still some 5 points below the 4,000 point level – the NAB note that “there is considerable political and social sensitivity for authorities related to the share market collapse”.

The bull market that turned into a bear explains why Chinese policymakers through everything bar the kitchen sink to support the nation’s stock market in recent months.

State-controlled insurers and pension funds were ordered to buy stocks. Brokers also agreed to purchase shares, and promised to not to sell until the benchmark Shanghai Composite index returned to at least 4,500 points. Some investors were also banned from selling down their holdings for a period of six months, among others.

A ban on short selling by some market participants, along with the potential arrest of those who short-sold maliciously, were some of the most publicised measures implemented.

Clearly, as the chart below shows, they’ve had an impact – short sale volumes have plummeted in recent weeks.

Having seen the wild swings in China’s stock market stabilise in August, the question many are now asking is whether Chinese authorities will be willing to let market forces play a greater role in determining the future direction of the stock market.

Given the PBOC’s surprise decision last week to allow market forces to play a greater role in determining the level of the Chinese renminbi, it’s a valid question to ponder.

While the PBOC move may have been designed to increase the likelihood of a near-term inclusion of the renminbi in the IMF’s special drawing rights (SDR) basket, the NAB believes authorities will not be so forthcoming when it comes to allowing market forces to play a greater role in the stock market.

“Facing the need to sustain solid growth to create jobs, limit over-capacity and to keep bad debt ratios under control, the Chinese authorities would be expected to err on the side of keeping growth up and hope that further expansion will, yet again, take care of any adverse medium term consequences”, say the NAB.

Longer-term, while “it may well be that market forces take on a greater role in driving the economy”, the NAB do not expect “authorities to simply or rapidly relinquish the field to purely market driven outcomes”.

“Instead they will continue to use their considerable leverage to ensure that market outcomes fall within a politically acceptable range”, they note.

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