Chinese Government Stirs up an IPO Mania

This looks like another example of how governments use stock markets as communications medium to project economic growth or recovery for political goals. 

The Chinese government, whom has controlled the pricing of mainland Initial Public Offerings (IPO), have fueled a debt finance speculative mania. 

From Bloomberg: (bold mine)

Zhang Xiuli says she knows nothing about the nine Chinese companies that held initial public offerings last month.

Not a problem. Zhang, 37, tried to buy shares in each and every one, confident that she knew what was coming next: an immediate surge in price that has rewarded investors in Chinese IPOs with an average first-day gain of 43 percent this year. Her orders were among 655 billion yuan ($106 billion) of bids for 3.2 billion yuan of new shares, an over-subscription rate 28 times bigger than that of Agricultural Bank of China Ltd.’s listing at the height of the nation’s IPO boom in 2010.

New stocks have regained their reputation as can’t-lose bets in China just four years after that last frenzy ended badly -- a majority of IPOs in the second half of 2010 saddled investors with losses within a year. The soaring demand shows how regulatory efforts to ensure deals aren’t overvalued have led speculators to ramp up bets with borrowed money and hurt plans to let the market, rather than the government, set prices in the biggest emerging economy, said Ding Yuan of the China Europe International Business School.

The above account of the "successful" retail punters partly reminds of me of the Philippine version--'basura queen' of 2007.

Next, IPO pricing regulations by the government

All nine companies that had IPOs last month sold shares at price-to-earnings ratios below the industry average, according to data compiled by Bloomberg. The regulator requires any firm pricing stock at levels above their peers to postpone the offering by three weeks and issue risk warnings to investors.

The incentive and mechanism that has powered the IPO mania...

The perception that IPOs are riskless has encouraged some investors to use borrowed money, exposing them to deeper losses once prices stop climbing, according to Lin Jin, a senior analyst at Shenyin & Wanguo Securities Co. in Shanghai.

China’s benchmark money-market rate rose the most in three weeks on July 23 as orders for five IPOs spurred an increase in demand for borrowed funds. The central bank said yesterday that the deals helped fuel a record drop in local-currency bank deposits last month as customers shifted funds to their brokerage accounts.

“The main risk is whether borrowing costs can be covered,” Lin said. “As new share sales become the norm, the effect will taper off and returns will decrease.”

Investors’ rush into Chinese IPOs, which have rallied an average 94 percent from their issue price this year, or seven times more than the global average, contrasts with lackluster demand among local investors to participate in the broader stock market. Traders have liquidated about 1.3 million mainland equity accounts since the end of March, leaving the number of funded accounts at a four-year low of 52.55 million.

So forcing companies to issue IPO prices at below market prices has naturally fostered outsized demand. And such demand which has been lapped up by the gullible public has been mainly financed by debt.

The IPO manipulation scheme seems also intended to reverse liquidations by stock market investors during the recent past.

As one would note, people hardly learn from the past or from history.

Yet all these speculative hysteria have emerged amidst an unexpected slump in credit last July.

From the Wall Street Journal

The latest batch of government data showed a stunning drop in growth in China's financing activity in July—a troubling sign in an economy where debt has become critical to expansion. Total social financing, the broadest measure of lending, expanded by 273 billion yuan ($44 billion) from June, the slowest since the collapse of Lehman Brothers.

The numbers were enough of a shocker—and possibly something of an anomaly—that the central bank felt it necessary to accompany the data release with an unusual written statement explaining that its policy stance hasn't changed. It said July's slump was explained by higher-than-normal lending in June of nearly 2 trillion yuan, among other factors. July has historically been among the slowest months for credit creation. The statement hinted that lending in August has gotten off at a more normal pace.

So this explains the recent 1 trillion yuan ($171 billion) via "Pledged Supplementary Lending" (PSL) as I previously noted.  Chinese authorities must have or has most likely been apprised or informed of this slump, so they launched the Quasi QE. The PSL QE hybrid hopes to provide cushion to this credit drought which authorities recognize risks amplifying the downturn in the property-credit channel.

And it appears that in order to camouflage the extent of credit troubles, and as part of the communications campaign, the Chinese government seems to have resorted to the massaging of the stock markets via IPOs first, in the hope that this will spillover to the rest of the market, in order to project a boom or a recovery to keep the credit flowing.

Yet whether it is about the stock market or property, the promotion of speculative activities has one common denominator: DEBT.

This means that the "kick the can down the road" policy of promoting stock market speculation through debt will exacerbate and compound on excessive leverage conditions in China's highly fragile system, or simply credit risks, which makes her a candidate as trigger to a global black swan event.

As I have been repeately saying here, the thinking of authorities goes like this (and this applies almost everywhere): We recognize of the addiction problem. But the withdrawal syndrome would be cataclysmic. So we will keep the (debt) party going!