By August 24th of this year, the Shanghai Composite had crashed 42% from its June 12th peak of 5,178.19 points. Leading up to the crash, the Chinese market had been steadily inflated and propped up by a combination of government stimulus and margin loans. Millions of Chinese citizens buy on margin by using borrowed money to purchase stock, a sector which Bloomberg estimated to be 2.26 trillion yuan (354 billion USD) in mid-June. The large dependence the Chinese A-share market has on margin financing is such that any regulation put in place will have huge effects on the market, as seen by the recent months of volatility.
To make things worse, in July the Chinese Securities Regulatory
Commission eased collateral requirements for margin financiers, allowing for up to 1.3 times the initial cash investment, making efforts towards what they believe will ameliorate the market free-fall. The reality is that the true size of the margin lending sector probably surpasses the 2.26 trillion estimate, as small web-based financing companies sometimes provide up to 10 times leverage and lack the amount of visibility official margin lending companies have.
Tonight, Chinese president Xi Jinping made optimistic comments
concerning the growth of the Chinese stock market in his public speech in Seattle, stating that the “Chinese stock market has reached the phase of self-recovery and self-adjustment”. While I believe the exit of 1 trillion yuan (156 billion USD) worth of margin accounts from the Chinese stock market is beneficial, indicating a decrease in speculative trading among investors, it is unclear whether there will be steady growth in Chinese equities going forward. The crash revealed that some of the world’s highest valuations may be unfounded and due to middle class speculation. Xiaomi, Chinese smartphone startup, earned a measly net profit of $56 million in 2013 according to public filings (approximately 1.8 percent operating leverage), compared to a $45 billion valuation at the end of 2014.
However, all of this may be more worry than the situation warrants.
According to HSBC, only 15% of Chinese household wealth is in stocks. Of bigger concern is slowing Chinese economic growth and its results: decreasing consumption in China and the strengthening of the dollar, decreasing US exports.