22 October 2016
Some investors believe that the recent plunge in stock prices may benefit the market as it will discourage excessive speculation. Photo: Reuters
Some investors believe that the recent plunge in stock prices may benefit the market as it will discourage excessive speculation. Photo: Reuters

Top 10 reasons for recent A-share corrections

Chinese shares plunged last Friday. Was it a mere correction or the start of a crash? 

There are various views on the market slump:

1) The sharp fall may lead to a modest rebound. It shows that A shares do have the peak and the bubble has started to burst last week. There will be a re-rating of valuations after big investors reduced their holdings and authorities ordered a tightening of leveraging activities.

However, the market may post a modest uptick this week after going through a sharp fall. That does not necessarily mean that the market is likely to bottom out.

2) Some investors are expecting a dramatic rebound. The sharp decline actually benefits the market as it has suppressed the overly bullish sentiment. Investors will become more mature and less panicky after learning lessons from the market’s ups and downs.

They believe the market is likely to post a dramatic rally again once investor confidence has been restored. However, the bull cycle for overly speculative stocks may be winding up. On the other hand, the turning point for a bear market has yet to come as capital continues to flow from pension funds and foreign investors.

3) Accelerated new share sales have taken their toll on the market. Giant offerings have drained massive capital out of the market, and this in turn has affected liquidity in the secondary market. As such, the market slump should not have surprised the market.

4) Some believe investors should take advantage of the market correction to accumulate good stocks. Any sharp fall in the bull cycle is a good buying opportunity. If investors have a strong conviction about the bull market, they would hold on to their stocks, while others may even increase their holdings if they have sufficient capital.

5) Other investors believe sharp volatility would become the “new normal”. The supply gap is unlikely to ease anytime soon given that the reform of the initial public offering market is still under way. The short supply will trigger an insane market run-up, which is usually followed by a free fall. That could become the new norm of the mainland market.

6) The deep fall would help mitigate the sell-off pressure and pave the way for an extended bull market. The market has gone up too quickly, although the economy has failed to stage a “U-shaped” rebound and the government has yet to unveil any massive stimulus. As such, the recent market slump would phase out stocks that lack strong fundamentals and support quality companies.

7) Margin financing and short selling have slipped out of control while the IPO reform has made very limited progress. These are the two largest headwinds for the mainland market. There will be less fluctuations if both issues are effectively tackled.

8) Some believe the recent market plunge was actually a deep correction, which would make the market more healthy. The central government has yet to change its stance towards the stock market. Investors just need to have more patience and hold on.

9) The pessimistic sentiment will fade away after the holiday break, as mainland investors are still getting used to the new norm of sharp ups and downs in the market.

10) The influx of new share offerings has cooled the red-hot stock market. That would calm down investors and correct the misconception that they will always make money from the stock market.

This article appeared in the Hong Kong Economic Journal on June 22.

Translation by Julie Zhu

[Chinese version中文版]

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Senior investment banker

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