09 Jul 2015
By Penghui Sun, Equity Analyst, Delaware Investments Real Estate Securities and Income Solutions (RESIS) Team
Starting Monday, the Chinese government began buying equities on the open market in an attempt to stop a slide in share prices that has reached historic proportions; since mid-June, the Shanghai stock market has fallen nearly 33%. Through June 12, the market’s year-to-date gain had been 149% (source: Bloomberg).
The government-controlled Securities Association of China said that 21 big brokerage firms had agreed to set up a market stabilization fund worth at least $19.4 billion to buy shares in the largest, most stable blue-chip companies. These firms, as well as China’s National Social Security Fund, will also stop selling shares from their own portfolios. Furthermore, the government suspended initial public offerings in the A-share market, and the central bank promised to provide liquidity support to China Securities Finance Corporation, which is the clearinghouse for margin financing and stock lending businesses in China. (source: Bloomberg.)
So far, these moves haven’t put an end to panic-driven selling in the market. Although the government keeps expanding its rescue package, we think it’s unlikely that the A-share market can be put on a bull-market track once again. We believe there are at least two significant reasons for this.
First, deleveraging in the market is far from over, with margin pressure remaining enormous. In total, securities brokers now have 1.6 trillion renminbis in A-share margin positions outstanding. While this is down 28% from the mid-June peak of 2.3 trillion renminbis, it is still four times what it was a year ago (source: China Securities Finance Corporation). In addition to the “official” margin financing, it is estimated that another 1.0–1.5 trillion renminbis of “unofficial” margin positions (typically with higher leverage ratios) are outstanding within so-called shadow banks, including trust companies, private financing companies, and peer-to-peer lenders (source: UBS). These excessive margin levels are troubling because they contribute to a vicious cycle: as stock prices keep falling, deleveraging pressures rise, forcing more people to sell their holdings.
Second, the A-share market still looks expensive even after the recent downturn. Consider, for instance, that the Shanghai Stock Exchange Composite Index is still 70% higher than it was a year ago (source: Bloomberg).
With pessimism persisting among Chinese investors (despite government measures to restore confidence), we think the proper functioning of China’s domestic capital markets will likely be distorted, and it will have a negative effect on household wealth and consumption. This in turn could exacerbate a stall in economic growth and a deterioration in corporate earnings.
The views expressed represent the Manager's assessment of the market environment as of July 2015, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
Investing involves risk, including the possible loss of principal.
Past performance does not guarantee future results.
International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations. Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
The Shanghai Stock Exchange Composite Index tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. (A-shares are typically only available for purchase by mainland Chinese citizens, while B-shares are available for domestic as well as foreign investments.)