NAB: China’s share market emerges as a key economic risk

China Photos/Getty Images

China’s stock market rally has divided opinion across markets. After more than doubling over the past year, questions are being asked if it can continue it’s unrelenting march higher or, alternatively, whether it’s merely akin to a pack of cards ready to fall.

While the NAB don’t offer an opinion on its future direction, they do believe that “China’s share market emerges as a key economic risk in early 2015, as industry remains weak”.

As a reminder of recent developments in Chinese stocks, the chart below show the performance of the Shanghai Composite (in black) along with the recent surge in the number of stock trading accounts opened (in red).

As you can see there’s been an absolute frenzy. As the stock market went up the number of people opening accounts to chase the gains has been exponential.

Based on analysis from the NAB, the rally lined the pockets of investors and contributed significantly to economic growth in the first quarter of the year.

Last month, we highlighted the shifting pattern of China’s growth in the first quarter – with notable weakness in the industrial sector partially offset by growth in services (which accounted for just over half the economy in Q1). More detailed accounts (released after our previous report) revealed the key driver of services growth was the finance sector – which contributed 34% of year-on-year growth for services in Q1, compared with just 18% in Q4 2014. Given the modest growth in bank loans and the weakness in the shadow banking sector, it is likely that the growth in finance has been driven by brokers – reflecting surging activity in domestic share markets in Q1.

They express concerns over the sustainability of the rally given deteriorating fundamentals and the less-sophisticated nature of the investors who are driving it.

New investors have been pouring into the market – with over 4 million new trading accounts opened in the third week of April (sixteen times the long term average) – driving the Shanghai composite index to a seven year high (despite slowing economic conditions and weakening corporate profits). There are legitimate concerns around the sustainability of these recent trends – particularly given recent attempts to cool margin trading. A recent study by the Southwestern University of Finance and Economics showed that just one-third of new investors in the stock market had graduated from high school.

Despite leaving their economic growth forecasts unchanged this year and next, NAB warn, “a major share market correction could pose significant risks for China’s growth – particularly the transition towards a consumption based economy”.

Given industrial data has failed to improve in April — if anything it’s become weaker — and the knowledge that growth in services during the first quarter was propelled by activity in the financial services sector, it would appear that this “significant” risk is growing.

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