Chinese Stocks Crash 7.7% on Margin Trades Crackdown by Authorities

As I have repeatedly been saying here, stock markets have been about credit and liquidity from which confidence is an offspring.

Take away credit and liquidity and the whole illusion of confidence built on them collapses.

Today, events in China has validated my thesis. A rigid crack down by the Chinese regulators on margin trades or credit extended by brokerage firms to clients has resulted to a harrowing one day stock market crash!

From the Bloomberg: (bold added)

Chinese equities plunged the most in six years, led by brokerages, after regulatory efforts to rein in record margin lending sparked concern that speculative traders will pull back from the world’s best-performing stock market.

The Shanghai Composite Index (SHCOMP) sank 7.1 percent to 3,138.59 at 1:59 p.m. local time, poised for the steepest drop since June 2008. Citic Securities Co. (600030) and Haitong Securities Co., the nation’s two biggest listed securities firms, fell by the 10 percent daily limit after they were suspended from lending money to new equity-trading clients. Industrial & Commercial Bank of China Ltd. tumbled 9.7 percent. The stock gauge’s 30-day volatility rose to a five-year high.

The penalties have raised concern that policy makers are trying to curb a surge in stock purchases using borrowed money, after outstanding margin loans surged to 1.08 trillion yuan ($174 billion) as of Jan. 13 from about 400 billion yuan at the end of June. The Shanghai Composite index has jumped 61 percent during the past 12 months on record volumes as individual investors piled into the market…

Citic Securities, Haitong Securities and Guotai Junan Securities Co. (1788) were suspended from lending money and stocks to new clients for three months, the China Securities Regulatory Commission said on its microblog on Jan. 16 after the market closed.

The regulator punished nine other brokerages for offenses including allowing unqualified investors to open margin finance and securities lending accounts, it said.

Last December I asked if the PBOC has been funneling banking loans indirectly to the stock market.

The same news report provides an affirmation of my suspicions:

On the same day, the China Banking Regulatory Commission banned banks from lending to companies that borrow to invest in equities, bonds, futures and derivatives. So-called entrusted loans extended by banks increased to about 458 billion yuan in December, the most since data became available in 2012.

So we seem to be witnessing a clash in policies.  The Chinese central bank, the PBoC wants to more credit into the system--yet  part of these funds finds its way to the stock markets--while the Regulatory Commission desires to curtail speculative credit flows into the stock markets.

So which agency will prevail, the PBoC or the Regulatory Commission?

The Shanghai Composite closed the day with a 7.7% crash! This again as reported, represents the steepest one day drop since 2008.

Also today’s episode highlights the reality that market crashes have become real time events.

And today’s 7.7% SSEC crash have virtually erased the year’s early sharp gains. The blue horizontal line above shows the level of today’s close.

Now of course, the Shanghai index had a 5.43% crash last December which it swiftly recovered.

The question now is how consistent will Chinese regulators implement the margin debt curbs? Margin trade controls essentially implies tightening of credit on stock market speculations.

So if regulators will continue to tighten then today’s crash could mark an inflection point for Chinese stock markets.

Given the huge growth of stock market credit or the record levels of margin debt, losses from today’s crash will likely lead to margin calls which may prompt for even more selling. And absent access to new credit many heavily levered firms will see their balance sheets impaired from sustained stock market losses.

But if regulators are here just to put a brake, or in effect, a façade at it, then today crash could just be part of the script to a manipulated boom.

At the end of the day, any credit inspired stock market ramp, is by its very nature, unsustainable. Chinese regulators seem to have become cognizant of its perils for them to implement today's crackdown.

As I always say here, the obverse side of every mania is a crash.