China’s stock market got wrecked on Friday with the Shanghai Composite index crashing by 7.4%.
The red-hot market is now down 19% from its high, which it set on June 12.
Some folks may see this as a buying opportunity, but not the analysts at Morgan Stanley.
“[T]his is probably not a dip to buy,” Morgan Stanley’s Jonathan Garner said. “In fact, we think the balance of probabilities is that the top for the cycle of Shanghai, Shenzhen and Chinext has now taken place.”
With the housing market stagnating, savings products offering no returns, and restrictions preventing investments overseas, China’s investor class have poured their money into the domestic stock market. The number of new brokerage accounts boomed and the amount of margin debt borrowed to buy stocks surged. Even after Friday’s crash, the Shanghai Composite is up 104% from a year ago.
But now the market forces have turned.
“We remain concerned over four factors,” Garner continued. “a) increased equity supply, b) continued weak earnings growt in the context of economic deceleration, c) high valuations, and d) very high margin debt to free float market capitalisation.”
Garner warns that the Shanghai Composite, which closed at on Friday, could have much farther to fall.
“We set a new 12-month Target Price range for Shanghai Composite of 3,250-4,600,” he said. “This range is ~30% to -2% below the current level of the index.”
Garner’s not kidding when he warns of the 30% downside. While a crashing stock market could be bad enough to trigger some social instability, it’s not without precedent to see regulators allow the market to just collapse.
“For us, ultimately this argument against a sustained bear phase for China A shares over the next 12 months sounds almost as dubious as what we were hearing in late 2007,” Garner said. “Then, it was frequently argued that the Chinese authorities would not let the A share equity markets decline before the major international prestige event of the Beijing Olympics in August 2008. The Shanghai Composite fell by 57% from the peak in October 2007 to the opening days of the Beijing Olympics.”