Don't be afraid of short-term corrections

May 06, 2015 13:34
In the absence of a major policy stimulus, the market may lose its momentum in the coming days. Photo: Reuters

China’s A-share market appears to have run out of steam in recent days, after the Shanghai Composite Index touched a seven-year high of 4,572 points and the market turnover surpassed 1 trillion yuan (US$161 billion) on April 28.

The Shanghai and Shenzhen markets lost 4 percent on Tuesday, and the market turnover continued to decline in the past few days.

Nonetheless, the mainland market has been performing fairly strongly over the last six months, during which a daily drop of more than 3 percent happened only four times.

The market quickly recouped its losses in the last three declines, and it took five trading days at the most for it to return to the level before the slide. Any remarkable correction has yet to be seen.

The trigger for three market falls is the regulation on margin trading and short selling business by brokerages.

However, Tuesday's market slide was not due to any official government policy, but resulted from some market rumors.

Changjiang Securities released a report saying Chinese authorities might impose 0.1 percent stamp duty for both sides to replace existing one-way 0.1 percent stamp duty in the third quarter of this year due to fiscal capital shortage.

If this happens, China’s annual stamp duty revenue could reach more than 280 billion yuan given the daily market turnover of 1.6 trillion yuan last month. That would be sufficient for fill in the fiscal gap, and even result in a surplus of 110 billion yuan.

This speculation, however, became the catalyst for a deep correction.

Market gains have gone too far over the past month, and the market is under increasing pressure for a correction.

The China Securities Regulatory Commission has been cautioning investors about market risks since mid-April.

In a May 4 commentary, the official People’s Daily said investors should be wary of risks amid a bull market.

The absence of any policy incentives, together with denials of rumors about mergers of state-owned enterprises, led to the market correction.

Over the last six months, the mainland market has been mainly driven by ample liquidity and expectations of government policy. However, it takes time to implement these policies, and it’s impossible to announce a new policy on a daily basis.

In the absence of a major policy stimulus, the market may lose its momentum in the coming days.

And since the pension fund has yet to join the bandwagon, retail investors continue to dominate the market. However, the source of new funds flowing into the market remains unclear as individual investors are assumed to have already bet all their money.

The latest correction is a case of profit-taking as we can't find any negative news. There is no obvious reason for an across-the-board correction.

As such, the market may regain its momentum within one week, judging by what happened in the past few months.

This article appeared in the Hong Kong Economic Journal on May 6.

Translation by Julie Zhu

[Chinese version中文版]

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a columnist at the Hong Kong Economic Journal