China’s stock market has suffered huge losses in recent weeks. And the situation is getting worse as authorities have done a poor job in restoring market confidence. The market meltdown may pose a great challenge for Chinese leaders, who are keen to push ahead financial reforms.
The priority at the moment is to shore up investor confidence and rebuild the credibility of the central government.
The rally in the A-share markets earlier had been driven mainly by domestic investors. Given the long-standing issue of rampant run-up without adequate checks, the current mess is not surprising.
Beijing has cracked down on excessive leveraging, and rightly so. However, up to 80 percent of the investors in the mainland market are individuals. Meanwhile, some mutual funds and brokerages have also been following the momentum like retail investors. In this situation, the government money has only bailed out some heavyweight and ETF plays.
Meanwhile, millions of retail investors who have relied on margin financing or speculating on the Growth Enterprise Board has already suffered immense losses. The deep correction was poised to come sooner or later, given that the valuations of A-shares had surpassed their fair value.
However, the pace of the correction has arrived much quicker and stronger than one would expect for such a closed market.
A-shares could stabilize for the time being after Beijing unveiled various measures to pump more liquidity into the market and also suspended new IPO deals. However, we would see a high level of volatility in the short term, and stocks on the Growth Enterprise Board may take even longer to recover.
Many foreign investors have booked profits in light of high valuations, and MSCI has postponed the inclusion of A-shares in its key emerging markets index.
Now, we can draw some lessons from the current market rout. First, investors have to understand the opportunities and risks of a retail-driven market, people’s investment habits, as well as the government role and measures in bailout.
The central government has released some bailout measures that go against the spirit of financial reform. That said, mature markets like Hong Kong, US and Europe also experienced rude intervention amid critical moments.
Foreign funds will flow into the mainland market as long as there is positive sign of economic growth.
Hong Kong has put in place mature regulation and supervision after going through various crises during the last two to three decades. The risk management on stock trading and margin financing should offer some valuable lesson for A-shares.
I’m uncomfortable when I see some senior officials of Hong Kong Exchanges & Clearing (00388.HK) trying to transform the local market into something that caters to investors from across the border. The city should leverage on its own experience rather than cater to mainland investors.
A-shares have already entered a “slow bull” cycle. In this situation, most small-cap counters lacking fundamental support will suffer a sell-off.
The Hang Seng Index is expected to find good support at around the 25,000-points level. One should therefore accumulate stocks gradually in the range of 24,000 to 25,000 points from the medium-term investment perspective.
Meanwhile, Hong Kong’s housing market has also come under the spotlight following the A-shares meltdown.
Most local home buyers are focusing on flats priced in the HK$5 million to HK$6 million range amid tight supply. But as the mainland stock market has lost 18 trillion yuan during the recent sell-off, investors should ponder about the potential impact on Hong Kong.
Will fund flows from the mainland dwindle and trigger a housing market correction in the city?
This article appeared in the Hong Kong Economic Journal on July 7.
Translation by Julie Zhu
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