China stocks sell-down: All to end in tears?

It’s perhaps a dramatic scenario to paint, but if the Shanghai composite were to lose a similar number of points over the next two consecutive days as it has been doing, we could be in bear territory in just the blink of an eye. This just after hitting a new high earlier this week. Luckily to formally be classified as a bear market though, it would have then to be held there for the next two months. But think about it. For an index that has added more than 120% over the past year, losing 20% may be casually regarded as simply a minor correction, simply a profit-taking trim off. Yesterday’s late day sell down, however, was a little more panicky. Around 500 stocks - or roughly 15% of stocks - traded in China’s stock markets closed ‘limit down’, a 10% maximum daily move. In these cases, stocks that were ‘limit down’ closed the day with only sellers on the board. With the excuse coming from a (reportedly) overdue clamp-down on margin lending by local brokers, together with worries over a liquidity drain due to a heavy calendar on the IPO front next week, the selling may just continue for a few days, as the scramble for the exit door intensifies. A game of ‘fastest fingers first’ may just play out as dealers rush to submit orders in the morning, against the expected flow of forced selling from margin calls that have not been topped up. From a mathematical viewpoint, the absolute amount of a 10% draw down is more than a 10% gain. Losing 10% not only feels more painful than the joy of making a 10% profit. The amount is actually more! Worryingly too, because China’s year-long 120+% move up was backend-loaded in nature, a lot of novice traders and investors were seduced by the promise of a quick buck very late into the game, near the current top of the market. The recent explosion in daily volumes and new accounts opening highlights this theory. Sadly, most of these newcomers may not exactly have the fastest fingers to get them safely out. With early indications pointing to a slight uptick in the futures for Chinese equities this morning, betting on a strong rebound may be a little premature as we may first have to negotiate the ‘Friday’ and the ‘end-of-month’ idiosyncrasies’ of stock markets.
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