China’s stock sell-off likely to end as indicators show narrower price swings

Although mainland stocks have fallen 6pc from this year’s high, weekly swings on the benchmark index and volatility measures have abated

PUBLISHED : Monday, 08 May, 2017, 6:48pm
UPDATED : Monday, 08 May, 2017, 10:14pm

Even as China’s stocks continue to decline in value, volatility indicators are showing signs of stability in a trend that bodes well for mainland equities.

Although the benchmark Shanghai Composite Index has fallen 6 per cent up to Friday from this year’s high on April 11, weekly swings in the gauge decreased for a third straight week and a volatility measure of the 50 most valuable companies on the Shanghai exchange slid to a record low last week.

Less volatile price swings probably signal that the month-long decline in China’s stock market, triggered by top policy makers’ intensified moves to reduce leverage in the finance industry, may be coming to an end, according to analysts.

“Volatility is kind of the leading indicator for the market,” said Wei Wei, a trader at Huaxi Securities. “The odds are increasing that the index is moving to the bottom.”

The five-day fluctuation in the Shanghai Composite narrowed to 2 per cent last week from 2.6 per cent and 2.1 per cent in the previous two weeks. The China volatility index, a gauge of implied fluctuations for the 50 biggest stocks on the Shanghai exchange over the next 30 days, slipped to a record low of 9 on Thursday.

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Other technical indicators are also showing that stocks may rebound at any time. The 14-day relative strength index for the Shanghai Composite, a measure of the rate stocks rise or fall, dropped to 25 on Monday, the second day it was below the 30 threshold indicating stocks are oversold.

A mainland rally faltered last month after President Xi Jinping escalated the campaign to clamp down on irregularities in the financial sector in the lead-up to the top communist party leadership reshuffle later this year. In a rare move, he called for financial stability in a meeting that summoned the central bank governor and the chiefs of the three regulators overseeing the securities, banking and insurance industries.

Xun Yugen, a strategist at Haitong Securities, said the decline in the stock market was simply a one-off reaction to the crackdown on deleveraging and that the general range-bound pattern of the broader market remains unchanged in the medium term.

“The market correction is limited but it takes time to digest” the negative impact of tighter liquidity brought about by the increased scrutiny, he said.

The market correction is limited but it takes time to digest” the negative impact of tighter liquidity
Xun Yugen, a strategist at Haitong Securities

The Shanghai Composite has been seesawing in a 700-point range since the beginning of last year after a stock crash in 2015 that erased US$5 trillion in market value. The index lost 0.8 per cent to 3,078.61 on Monday, capping this year’s loss at 0.8 per cent.

For stocks to stage a comeback, daily trading volumes on the Shanghai and Shenzhen exchanges need to drop to about 25 billion shares, a level last seen when the market bottomed out in December last year, according to Haitong’s Xun. The lowest volumes over the past week were still 24 per cent higher than December, indicating selling pressure has yet to recede.

Haitong’s view was echoed by Shenwan Hongyuan Group. Though mainland stocks are not likely to start picking up until the third quarter, the market is already in the stage of consolidating, according to the Shanghai-based brokerage.

“A drop in the risk-free interest rate may happen in the third quarter,” said analysts Wang Sheng and Fu Jingtao at the securities firm. “But the process of consolidating at the bottom end has already started and the market’s volatility is likely to gradually decrease.”