“The market is now a falling knife”, BofAML said on Friday, referring to the harrowing 30% decline in Chinese stocks that has unfolded over the course of just three weeks, leaving the PBoC and various other government agencies scrambling to arrest the slide.
Cuts to both policy rates (benchmark lending rate and RRR) and daily “remain calm” pronouncements by various government agencies have so far proven woefully inadequate to combat the country’s margin mania unwind, leaving BofA to conclude that the only thing which can help Chinese equities now is direct buying on the part of the government.
As a reminder, the problem here appears to be related to the hodge-podge of backdoor margin buying vehicles that have combined to channel between CNY500 billion and CNY1 trillion in unofficial, off-the-books margin lending into stocks via umbrella trusts, structured funds, P2P lending, and a variety of other mechanisms that allow China’s millions of newly-minted retail investors to skirt minimum balance requirements and margin limits at brokerages.
Combatting the unwind may mean, in BofAML’s words, making the government “the buyer of the last resort in the market, similar to what HKMA did in 1998.” This would however, be complicated by the fact that “much of the unauthorized margins were used to buy small cap stocks, so the authority, with or without PBoC’s direct involvement, may have to buy stocks on a very large & very broad scale.”
One day later and China has already moved in the direction of direct intervention in the markets, although it appears Beijing will try to orchestrate a “private” sector (whatever that means in China) solution first before going the nuclear route with the central bank’s balance sheet. As Bloomberg reports, the country’s largest brokerages are teaming up to invest nearly $20 billion in “blue chip” Chinese equities:
Chinese brokerage firms have come together to set up a stock-market fund, the latest effort to stem the biggest three-week drop in China’s key share index since 1992.
The 21 brokers led by Citic Securities Co. will invest the equivalent of 15 percent of their net assets as of the end of June, or no less than 120 billion yuan ($19.3 billion) in total, the Securities Association of China said in a statement on its website Saturday. The fund will invest in blue-chip exchange-traded funds, it said.
The move comes after measures to shore up equities failed to stop margin traders from unwinding positions at a record pace, with the market losing more than $2.8 trillion of value in three weeks. The People’s Bank of China cut interest rates last week, while margin-trading rules were eased and trading fees were cut Wednesday.
The group of 21 brokers said the economic fundamentals that had justified the stock market’s rally before the rout hadn’t changed.
According to Caijing, they aren't wasting any time getting started (Bloomberg, citing Caijing):
China Securities Finance, which manages the nation’s short selling and margin trading, will pay for the brokers and buy ETFs at Monday’s market opening, Caijing reports on its website without citing anyone.
While selling, it appears, is quickly becoming taboo:
Top executives from 25 Chinese mutual funds, including China Asset Management and E Fund Management, promise to hold their stock funds for at least 1 yr, according to statement on Asset Management Association of China’s official website.
The move by the broker consortium is reminiscent of an ill-fated 1929 effort by JP Morgan and others to support the US market after Black Thursday and is, according to some, doomed to fail because i) it is a laughably small effort compared to daily turnover in China, and ii) it targets the wrong kind of stocks. Here’s Bloomberg again:
The new fund to bolster equities may have only “a fleeting effect when daily turnover has reached 2 trillion yuan”, according to Hao Hong, China equity strategist at Bocom International Holdings Co. in Hong Kong.
“This 120 billion yuan won’t last for an hour in this market,” Hong said by phone from Beijing Saturday. “It might benefit blue-chip stocks, as investors may see them as value, but the bursting of the bubble in small-cap/tech stocks is likely to continue.”
“The market’s most acute concern is still these smaller cap stocks, as investors levered up to buy them and now margin lending curbs hit them the hardest,” Hong said. “With their valuation in the stratosphere, nobody is willing to step in and bolster these stocks.”
In other words, this pilot program (so to speak) is woefully inadequate and by many accounts will be almost entirely ineffectual, meaning it will either have to be expanded meaningfully, or someone with some real firepower will have to step in instead.
The takeaway: it's probably just a matter of time before the PBoC interevenes to provide Kuroda-style plunge protection when "sentiment" looks to be souring, only in China, because the reckless margin buying is concentrated in small caps trading at nosebleed multiples, the central bank's balance sheet will become a repository for umbrella manufacturers, real estate developers-turned P2P lenders, and ponzi schemes unlike the BoJ's equity book which (at least as far as we know), is comprised mostly of ETFs.
So, for anyone wondering what the future holds for China's (formerly) world-beating equity markets, here is a hint:
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Full statement from Securities Association Of China:
2015 On 7 July 4 days, 21 securities companies held a meeting to analyze the current stock market situation, confidence in China's capital market development, agreed that firmly maintain the stable development of the stock market. It was decided :
First, the 21 securities companies in 2015. In June of net assets at the end of a 15% contribution for investment in blue chip ETF .
Second, the Shanghai Composite Index at 4500 points or less, in 2015 on 7 May 3 , based on the balance date, the securities company's own stock plate is not underweight, and choose overweight.
Third, the listed securities companies will actively promote the company's stock repurchase and advance major shareholders of the Company increased its shareholdings in stock.
Fourth, in accordance with the relevant provisions of the CSRC issued the "margin trading business management approach", the perfect counter-cyclical adjustment mechanism, timely adjustment margin ratio, discount rate backed securities, securities lending business scale and other related indicators, in the risk controllable smoothly as possible under the premise of good customer defaults disposal.
Full statement from Asset Management Association Of China:
July 4, 2015, 25 companies raised funds held a meeting, in-depth analysis of the current capital market situation and the fund industry's overall trend. This year, despite the sharp adjustment of market experience, as of July 3 accumulated net partial stock funds average growth still reached 31.87%. At the same time, partial stock funds share a substantial increase, since nearly two weeks I. The state as a whole is still showing.
Participating companies to the capital market confidence in the future, convinced that the parties to the collector of the market, fully qualified, have the ability and confidence to maintain stable and healthy development of capital markets. The meeting held that the capital market is an ecosystem that has its own operating rules, irrational chase and sell are dangerous. After the recent sharp correction in the market, many stocks have been shown to investment value, number one hundred billion additional funds raised to provide a rare investment opportunity.
Participating companies will actively practice initiatives:
First, open the subscription period before purchase fund to provide investors with more choices.
Second, market opportunities, speed up the declaration and issuance of partial shares of the Fund, and in accordance with the provisions of the fund contract, the completion of the new funding positions.
Third, the company chairman and general manager of the fund participants promise: The company actively purchase partial stock funds, and hold at least one year or more.
Participants will actively act, continue to carry out "entrusted by the people, generation financial management" duties, adhere to long-term investment, rational investment, work together to maintain capital market stability.
Participating units: Huaxia Fund Management Company, E Fund Management Company, ICBC Credit Suisse Asset Management, Harvest Fund Management Co., Wells Fargo Fund Management Company, China Southern Fund Management Company, Penghua Fund Management Company, China Universal Fund Management Company, the Bank Fund Management The company, investment fund management companies, CCB Principal Asset Management Company, Guotai Fund Management Company, Boshi Fund Management Company, Yinhua Fund Management Company, Dacheng Fund Management Company, Central Fund management companies, Societe Generale Global fund management companies to finance the fund management company, Hua Tai Borui fund management company, Chinese fund management companies, Oriental fund management companies, Post & Capital Fund Management Company, Manulife Teda Fund Management Company, Changsheng Fund Management Company, the State General Fund Management Company