China Sage Tips ‘Destruction’ of Leverage Trades as Stocks Slide

21-Apr-2017 Intellasia | Bloomberg | 6:00 AM Print This Post

Markets are only starting to feel the heat from China’s campaign to cleanse its financial system of risk.

That’s the view of Hao Hong, chief strategist at Bocom International Holdings Co. in Hong Kong who accurately called China’s boom-and-bust equity cycle of 2015.

Tightening in the money markets as China seeks to reduce leverage saw the bond market sell off at the end of last year. Now it’s equities’ turn. After barely moving for most of March as traders chased gains in Hong Kong, mainland-traded shares have slumped this week as a regulatory crackdown spooks investors. The ChiNext small-cap index, seen as a barometer for Chinese stock-market sentiment, has fallen to near a 19-month low.

“For now, it pays to stay cautious – I don’t think the bearish trend will stop here,” Hong said. “We’re going to see the destruction of trades that rely on very high leverage.”

This week’s rout – which has the Shanghai Composite Index down 2.3 percent since Monday – was “triggered” by signs Chinese authorities are seeking to rein in market speculation, said Hong.

The securities regulator has stepped up criticism of what it called disruptive trading behavior, with chief Liu Shiyu saying at the weekend China’s bourses should punish market irregularities “without mercy.” The country’s anti-corruption agency has also announced a probe into the head of the insurance regulator. President Xi Jinping and his lieutenants have made conquering financial risks one of their top priorities ahead of a twice-a-decade reshuffle of the political leadership later this year.

Margin trading rose to a three-month high on April 13 amid a rally in mainland shares partly driven by enthusiasm over China’s new economic zone, Xiongan. The outstanding balance of margin debt on the country’s two exchanges has since fallen to 932.6 billion yuan ($136 billion), from as much as 972 billion yuan back in November. The rapid unwinding of margin trades helped spark China’s $5 trillion equity market slump in 2015, which Hong predicted.

The realisation that China’s economic recovery is slowing will underpin longer-term bearishness when it comes to stocks, according to Hong, who cites the pullback in producer-price growth as evidence the rebound is losing steam. Iron ore’s descent is a sign momentum in the world’s second-largest economy is waning, he said.

There is also concern the crackdown could target commodity financing in China, “one of the most important sources of financing for many traders,” Hong said.

Shares in China, the world’s top consumer of the ingredient used in steelmaking, have been falling alongside prices for iron ore this week. The Shanghai Composite pared losses late Wednesday, however, continuing a trend of closing down by less than 1 percent, and were up 0.1 percent as of 10:36 a.m. local time on Thursday.

But any correlation between Chinese shares and iron ore is more likely to be the result of speculation, says Aidan Yao, a senior economist for emerging Asia at AXA Investment managers Asia Ltd in Hong Kong.

“I don’t think there is solid macro base for a large correction in Chinese equities given the recent data and corporate profits,” Yao said.

For Virginie Maisonneuve, chief investment officer at Eastspring Investments Ltd in Singapore, both the Chinese stock rout – and iron-ore’s collapse – will be shortlived.

“Investors should use the A-share selloff as a buying opportunity,” she said.

Some China stock bulls turned cautious earlier this year on concern over the impact of monetary tightening. One of those investors, Dai Ming at Hengsheng Asset Management Co. in Shanghai, says this is just the first round of tougher regulation and that there’s risk of a renewed selloff in bonds infecting equities.

“China’s financial assets have expanded at a worrying pace and bubbles have formed” he said. “If they’re not dealt with in a proper and timely manner they could trigger a financial crisis.”


Category: China

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