Chinese Stocks Suffers Biggest Weekly Crash since 2009!

Stock markets in China posted their largest weekly loss for the week since February 2009 according to a June 18 report from Bloomberg.

The report didn’t include Friday’s crash.

The table above from Bloomberg’s Asian Stocks Table exhibits Friday’s bloodbath.

Over the week, the Shanghai index hemorrhaged 13.32%, the Shenzhen composite 12.69% and the ChiNext 15%!

The Chinext benchmark as previously noted has been patterned after the Nasdaq and has been home for startups. The average ChiNext issues has been priced nearly 100 times earnings!

For the Shanghai and the Shenzhen index the crash came after last week’s record high.

For the ChiNext, the peak was on June 3^rd. So combined with this week, losses has accrued to 16.75%.

Despite this week’s fantastic dump, the Shanghai index still relishes a 38.45% year to date return.

And given the vertiginous parabolic ascent as shown in the left window (chart from Zero Hedge) where Chinese benchmarks has magnificently outpaced US stocks, then current downside actions look like a typical violent market response.

Of course, soaring Chinese stocks has been fueled by manic retail accounts mainly financed by credit (right chart from Zero Hedge) which have been in response to the goading of the Chinese government (right chart from Zero Hedge). 

Interestingly, the Chinese government’s China Securities Depository and Clearing Corporation Limited (CSDC) which keeps track of new stock market accounts seems to have forgotten to update their data (last update was on May 25-29 2015)

The initial cracks were seen at the IPO index

The Bloomberg IPO index returned more than 400% since 2014 178% in 2015 before last week’s meltdown, that's according to another Bloomberg report.

Since the public thirsts for explanation on what caused this, media has responded by offering many factors

The Wall Street Journal thinks that this has been due to tighter liquidity in response to the central bank’s activities PBoC:

This past week’s selloff was triggered by tighter liquidity in the market. China’s seven-day interbank repurchase rate, which is the borrowing cost among banks, jumped from 2.2% to 2.73% over the week. Since March, the People’s Bank of China was thought to be trying to keep the rate down by injecting more cash into the lending markets. But this past week, the central bank was absent from open-market operations, traders say, effectively letting the rate rise.

Broker tightening of credit had also been blamed

Brokerages in China already have been tightening requirements for lending to stock investors as a way to limit their exposure as share prices soared, and higher borrowing costs were liable to push them to further raise margin requirements. China’s margin debt reached a record $419 billion Friday, according to exchange data.

Investor frustrations over PBoC actions has likewise been attributed

Other signs also pointed to a tighter stance by China’s monetary-policy makers. Some investors were disappointed the central bank didn’t lower the required-reserve ratios—or the funds commercial banks are required to hold—this past week. In addition, the central bank published a report Tuesday predicting China’s economic growth would accelerate modestly in the second half of this year as the government stepped up efforts to spur growth, suggesting the bank might not lend a helping hand to the economy.

The Financial Times imputes this on a crackdown by authorities on credit flows from formal banks and shadow banks to stocks

Beyond officially sanctioned margin lending, regulators are scrutinising disguised lending by banks, brokerages and trust companies for stock investment.

Haitong Securities estimates that between $81bn and $161bn has flowed into the market via so-called umbrella trusts, in which trust companies sell structured products to investors offering a fixed return, using the money to invest in the equity market.

The Nikkei Asia also sees investor discontent on PBoC’s actions, as well as, investor irrationality out of 'the lack of safety nets'…

Investors wary of skyrocketing prices turned to selling to lock in profits. An improving real estate market was also a negative for the market as it dimmed prospects of additional monetary easing.

China's stock market is prone to volatile movements. Since the country lags in pension systems and other safety nets, individual investors are drawn to stocks, accounting for 60-80% of players.

Again all these seek to explain current events from price changes.

While there may be some grains of truth from the above, vertical price actions of stock markets are likely symptomatic of both Ponzi dynamics and the Greater fool theory in action. 

Ponzi dynamics require fresh money to bid prices aggressively higher from existing shareholders (mostly insiders) at current levels. Since vertical price actions have manifested sustained manic bidding up of stocks, which are likewise indications of pyramiding, then more fresh funds are required to sustain this manic trend. Otherwise, given the stratospheric state of stock prices, this would mean an avalanche of profit taking sellers.

Meanwhile the greater fool is when “an investor buys questionable securities without any regard to their quality, but with the hope of quickly selling them off to another investor (the greater fool), who might also be hoping to flip them quickly. Unfortunately, speculative bubbles always burst eventually, leading to a rapid depreciation in share price due to the selloff.” (Investopedia)

In short, manias are manifestation of one way trade crowd dynamics whose actions are premised from Greater Fool expectations backed by mostly credit financed (Ponzi) manic bidding of securities.

The credit crackdown or the reaching of credit limits (given record margin trades) could partly be responsible for the dearth of fresh speculative money to push prices at current levels.

The current stock market boom bust cycle has a predecessor (The bust in 2008-2009). 

At least then, the Chinese bubble had been buoyed along with the economy. Today, Chinese stocks have totally become detached from the economy!

I recently wrote that this bubble has been engineered by the Chinese government

The Chinese government seems to be hoping that the stock market boom may provide the economy an alternative of finance. They must be hoping that equity may replace credit as a source of financing for credit trouble firms, thus the stock market frantic pump matched by an avalanche of IPOs.

In addition, rising stocks could have been seen by the Chinese government as having the “wealth effect” enough to ameliorate the downturn in the property sector, spur consumer spending and create the impression that the Chinese economy has been recovering.

Little have they learned from their recent experience that the same credit bubble on the property sector has only incited for a huge imbalances. Huge imbalances that has to be paid for, which has been the reason for the recent downturn in the economy.

Yet once the Chinese stock market bubble crash, such will only aggravate and accelerate the ongoing downswing in the property bubble.

The lesson is: Two wrongs don’t make a right.

And it appears that my views have been validated because the major beneficiaries of the stock market bubble have been state owned companies. These companies have partly alleviated their onerous debt conditions through the tapping of equity financing and by inflating valuations.

The above chart from Bloomberg which shows the shifting of financing from lesser bond issuance to more equity financing also reinforces my views.

The Business Insider has the recent numbers:

A blistering rally in the equity markets enabled mainland Chinese companies to raise funds at a furious rate, with the year-to-date sum at a record US$97.1 billion, data company Dealogic reported on Friday.

The sum is 81 per cent higher than the US$53.6 billion fund raised in the same period last year. In terms of the number of deals, it was also up by 77 per cent to 434 deals year-to-date this year, from the 244 deals in the same period a year ago.

The deals are mainly driven by new listings or fund raising in the secondary market by Shanghai or Shenzhen listed A-shares, which account for US$57.5 billion and 279 deals, representing 59 per cent while the rest is composed of H-shares in Hong Kong and others that were listed overseas.

Of the total, 79 per cent or US$76.7 billion are related to listed companies which raised funds in the market by share placements, right issues or other offerings, which is also the highest on record.

And given that the Chinese government has been attempting to fill the gap or remedy the adverse repercussions from the colossal property bubble with another gigantic stock market bubble, this implies a transfer of resources and risks from the average Chinese’s savers to publicly listed firms (including SOEs)

So when the bubble pops, a significant chunk of the Chinese society will suffer.

Yet just look at how the stock market bubble has been reducing investments by diverting funds into speculative activities.

From the Wall Street Journal: (bold mine)

Take Dong Jun, who earlier this year shut down his factory making lighting equipment and electrical wiring and let go some 100 workers. The 50-year-old comes to the plant in the eastern city of Yancheng almost daily, but spends his time trading stocks on behalf of his company, Yanwu Keda Electric Co.

“Manufacturing is a very hard business these days,” said Mr. Dong, chairman of the company. “I want to make some money from the stock market and use the profits to restart my manufacturing business later, when the economy turns for the better.”

Chinese companies are finding stock investing an attractive option as the wider economy struggles with tepid demand, excess industrial capacity, persistently high borrowing costs and other troubles. Their interest poses a challenge for policy makers, who want to nurture markets companies can tap for investment capital, rather than creating a venue for speculation….

According to the latest official data, profits earned by Chinese manufacturers rose 2.6% from a year earlier in April, a turnaround from a drop of 0.4% in the previous month. Yet nearly all of that increase—97%—came from securities investment income, data from the National Bureau of Statistics show. Excluding the investment income, China’s industrial profits were up 0.09%.

Meanwhile, over the course of 2014, the value of stocks, bonds and other tradable securities owned by listed Chinese companies rose by 946 billion yuan ($152.4 billion), a 60% increase, according to an analysis by Mr. Zhu.

The Chinese economy has now been overwhelmed bubbles or consumed by or by malinvestments! 

When the twin bubble bursts, losses will be tremendous and this will have a wretched spillover effect to the world.

Nikkei Asia sees the Chinese government to come to the rescue…

But the Chinese government is not quite ready to let the stock market boom subside as it helps boosts personal spending. If the slide continues next week, Beijing could step in to prop up the market, as it is not likely to tolerate an excessive plunge.

Again the $10 trillion question will be where will the money come from? And will these be enough to overcome expectations of current shareowners? If the answer for the latter is yes then the boom will go on…until it can’t

The government will likely liberalize her stock markets to accommodate more foreign investors who may become the bigger greater fools. The Chinese government failed to get her domestic stocks included in the MSCI index which would have opened the gates for Western asset managers. I may add that this may have added to fund sourcing pressures in support of higher price levels for Chinese stocks.

We have seen a smaller version of such a crash last January. Then I wrote,

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.

Two days after the single day loss of 7.7%, regulators backtracked from the crackdown, Chinese stocks fully recovered from the he deficit and subsequently flew to new heights

Regardless of what the government does, the great Austrian economist Ludwig von Mises describes of the eventual outcome for the Chinese runaway bubble economy (Interventionism: An Economic Analysis p. 40)

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.