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The bungee-like behaviour of Chinese markets in the current climate

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Bungee, anyone?

The trading behaviour of Chinese markets over these past days is comparable to being hooked to a bungee cord, stretched to the limit in one direction, only to recoil just as enthusiastically back the other way, in almost the same breath! It’s been an emotional ride to say the least, more so if you are a trader stuck in a heavy, hopeful position. The ride yesterday was no different, with the CSI 300 exploring an almost-10% intraday range, head to toe – with some traders finding it a better buzz than jumping off a bridge attached to a rubber cord. The approximate 30% fall from grace of Chinese equities (from only 3 weeks ago), is actually ‘not that much’ if viewed with the perspective that even after taking yesterday’s closing, most Chinese indices are still up around 80% on an annual basis. The problem, however, is that the majority of market participants were late into this game, with the super year-long rally weighted heavily in the later stages of that year. Meaning to say, many novice traders and investors had only just got their feet wet at much higher prices, trading relatively concentrated positions, near the market’s recent highs in early June. Worse still, much of this exposure was reliant on margin financing. This may also be the key reason why Chinese stocks have yet to stabilise, despite repeated measures introduced by the central authorities’ margin unwinding. As prices decline, highly leveraged positions are required to be topped up.

Vicious cycle

If position holders are unable to do, stocks get forced sold. The resulting effect would be even lower stock prices, triggering further demands for margin top ups. This is a vicious cycle that will persist, until or unless two things happen to confirm we have hit bottom. First, a period of flat-lining for the indices is necessary; meaning to say, a few days of ‘unchanged’ or flat market action. Not only will this will bring a resumption of calm, but with it the deceleration of margin calls and forced selling. The second thing to look out for may have already been evident; buyers of last resort, or direct support for falling share prices. Last weekend’s announcement around the US$20bilion broker support fund may just offer a floor to tumbling share prices. The fund will primarily invest in blue-chip exchange traded funds. From the look of market action yesterday, perhaps we have already started to see its impact, as the Shanghai Composite managed a rebound of over 2%, despite the Shenzhen and Chinext - deemed more speculative in nature - each retreating by between 2 and 4%. With the blanket moratorium announced suspending further IPOs, together with pledges by local brokers not to sell their market positions below the 4500 level on the CSI 300, we may have seen a near-term bottom for the falling Chinese markets around here. On the flip side though, any move up from here may also see it capped at this new psychological 4500 level.
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