Across The Border
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Slump in China’s ‘new economy’ share index could be warning of dangers ahead

PUBLISHED : Thursday, 19 January, 2017, 5:33pm
UPDATED : Thursday, 19 January, 2017, 9:21pm

China’s small-cap stocks, or new-economy stocks, have plummeted in the first few weeks of January, sparking fears of a broadening sell-off that could lead to a replay of the 2015 stock market crash, analysts warned.

The ChiNext Price Index, China’s Nasdaq-style start-up board on the Shenzhen Stock Exchange, has fallen for 10 of the past 11 trading sessions as of Thursday’s close. Since the start of the year, the index has tumbled 6 per cent, touching 1,783, within striking distance of the trough of 1,779 in 2015. Mainland stock markets made a sudden U-turn in the second half of 2015, with the Shanghai Composite Index falling more than 30 per cent over a four week period beginning mid-June.

Many analysts attributed the sell-off in recent weeks to the large batch of initial public offerings approved by regulators. One concern is that speeding up the IPO pipeline will drain funds from the market and hammer the high valuations of small-cap stocks.

“The sentiment on new-economy stocks seems to be cooling,” said David Cui, strategist for Merrill Lynch, who has had a non-consensus bearish view on Chinese equities since December.

He cited data from CEIC as saying that total venture capital raised in China only grew 6 per cent in the first nine months of 2016, versus 180 per cent growth in 2015.

Crescat Capital, a Denver-based global macro hedge fund which overseas US$96 million in assets, has also doubled its bearish bets on Chinese equities, according to a recent report by Bloomberg.

The report quoted Kevin Smith, chief executive of Crescat Capital, as saying that China’s easy money policy will come to an end, as it clashes with the government’s efforts to support the yuan. He added that China’s attempts to back the yuan will tighten monetary conditions and make a credit crisis increasingly likely.

Major shareholders of listed Chinese companies may have also sensed a more difficult period ahead, as they rushed to dump shares while stock prices are still high.

Since December, more than 1.2 billion shares have been sold by major shareholders, worth about 22 billion yuan, according to data from Wind.

Some sell-offs by major shareholders were just “brutal” and in a “everything must go” style, state-run Xinhua News Agency said in a special report on Wednesday.

Pingxiang Fuhai, a major shareholder of Shenzhen-listed Sinovel, recently announced a plan to sell around 900 million shares of Sinovel in the next six months. The company dumped more than 300 million shares of Sinovel over three trading days in the final trading week of December.

“The fear is that a great amount of cash they raised by selling stocks is spent or transferred overseas, instead of being used to start a new business or reinvestment in China,” Xinhua said. “This will cause blood loss for China’s capital market and real economy.”

An estimated 203 billion restricted shares are due to be unlocked in 2017 in the Shanghai and Shenzhen stock markets, worth roughly 2.88 trillion yuan, according to Southwest Securities.

The dump could cause a vicious selling circle in the A-share market, analysts said.

Leverage in the A-share market, as measured by leveraged position as a percentage of total market cap, is higher currently than it was in mid-2015, according to Merrill Lynch.

Over half of the leverage is in the form of stock-collateralised loan (SCL), which is particularly heavy on the Small and Medium Enterprise (SME) and Growth Enterprise Market (GEM) boards.

As of 2016, value of collateralised stocks accounted for about 18 per cent of total SME/GEM market cap, versus 7 per cent for the rest of the market.

“As the 2015 experience shows, with high leverage, a vicious selling circle can quickly develop,” Cui said.

In 2015, the government managed to stabilise the market by acting as “the buyer of the last resort”.

But this time, it seems more unlikely for the government to directly purchase the stocks.

“In our view, the case for a government direct purchase programme is much weaker - most SME/GEM stocks are expensive private companies,” Cui said.

If the SME/GEM market collapses, there is “a moderate risk” that it could trigger broad-based financial instability, he warned.

A possible transmission could work in this way: the vicious selling circle causes big SCL losses for brokers, as they are the main provider of the stock-collateralised loans. Then banks become fearful to lend money to brokers and other financial institutions and brokers have to unwind bond positions due to balance sheet stress. A vicious selling circle in the bond market, which is also highly-leveraged, could occur thereafter, putting pressure on wealth management products (WMPs), which are large holders of bonds. Banks may take a hit on their earnings and balance sheets as well, as WMPs are largely their off-balance-sheet operations.

“There could be many other transmission channels in our view, given the financial system in China is fragile owing to the surge of leverage since the global financial crisis,” Cui said.

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