Chinese Stocks on Fire, Déjà vu or This time is different?

Summary

• CSI 300 Index representing overall performance of China A-share market gained 14% in the five days to trade at a five-year high, fuelled by state media signalling towards a boost required in the equity market fostering economic growth
• Retail investors had been the dominant force in triggering the price rally as they are optimistic about the Chinese economy which is showing signs of recovery by reporting better manufacturing and service PMI
• However, the rise in trading was also backed by margin loans that brokers provide clients to buy stocks, exposing the client towards loss if the price rally bubble bursts

Stock Markets around the world are in a price rally with indices soaring high post CSI 300 gained 5.7% to 4670 on 6 July 2020, and was up marginally by 0.6% to 4,698 on 7 July 2020. The on-going 2020 surge in CSI 300, representing overall performance of China A-share market, is a result of a positive statement from a Chinese media house signalling towards a need for a bullish equity market.

CSI 300 gained over 14% in the last five days and is currently trading at a five-year high. With the daily turnover at over ~1.5 trillion yuan ($213 billion) for the 1^st time since 5 years the shares of brokerages surged, indicating increasing participation from retail investors. According to media reports, retail investors in China are being optimistic about the Chinese economy that has been showing signs of recovery through better PMI post controlling the pandemic.

Mizuho strategist Ken Cheung highlighted that Chinese traders will now keep an eye on official media for signals to increase the price rally further.

The gain is the biggest since July 2015 when the Chinese share market was experiencing a bubble that went for almost a year. Out of 300 of the CSI 300’s shares, more than 280 shares ended with a positive trading session with banks and brokerage firms experiencing a intraday rally of almost 10%. The financial sector witnessed a surge of almost 9%. According to Bloomberg, margin loans in China that brokers provide clients with funds to buy stocks also increased to all time high since 2015.

During the last bubble of 2015, the CSI 300 Index jumped 23% in just two months, leading to higher profits for retail investors who were holding the stocks at a cheaper rate.

However, the economic backdrop is different between now and that of the 2015 which includes a lower starting point for equity valuations. Number of traders are far less now than what it was in 2015. The central bank is also controlling the liquidity cautiously while withdrawing funds from the financial system for a seventh day.

The 2015 bubble was driven by positive statements from state media signalling towards a boost from the dismal equity market. The result lead to a debt driven trading that resulted in creating bubble which burst to wipe out $5 trillion of value of shares, representing a 40% collapse.

Digging Deeper on factors that led to price rally

The recent surge is resulting out of a positive statement from a Chinese media house. The Chinese stock market started an upward journey as the China Securities Journal signalled that a bullish stock market will help foster the Chinese economy, especially driving the digital economy.

The low interest rates of Chinese wealth-management products are also prompting people to invest in stocks for greater returns.

The price rally also reflected the investors’ optimism on the economy post China reopened its economy, pumped up its manufacturing activities leading to a higher PMI above 50 points.

Rising level of margin financing is also acting as a catalyst. Mizuho strategist Ken Cheung highlighted rising level of margin financing which was worth 22 trillion yuan in June (2x since February), establishing itself as a key factor in driving the onshore equities market.

The central bank is also easing the credit and lending policies for the economy and businesses to sustain in the economy and grow. Investors are optimistic and banking upon the continued support from the central bank that is supporting the economy to keep on performing.

State of Chinese Economy

China’s economy is currently facing lot of difficulties including the ever-going China-US trade war that is proving to be detrimental for the both the economies and for other world economies. However, the Chinese economy is better posited currently. The economy is bouncing back with the effect of the pandemic subsiding and manufacturing activities driving up tertiary sector.

China’s June Caixin services PMI experienced a major jump and marks a ten year high at 58.4 from 55 in May. The Hong Kong PMI for June was recorded at 49.6 from 43.9 in May.

Despite resurgence in COVID-cases, the market participants remain bullish propelling the stock market backed by strong government intervention through grants and policies to keep fostering the economy. However, many seasoned investors are not as gung-ho as the new age investors. So, a good level of risk analysis might be called for before going headlong into the market.