Here's how China can stop the A-share carnage

July 08, 2015 17:39
Shen Yi thinks that the biggest problem with the A-share market is that investors cannot hedge their stocks by short selling futures. Photo:HKEJ

It has been a race to the bottom for Hong Kong and China stocks in recent weeks.

In that time, more than 1,241 firms have sought trading suspensions, nearly half of all companies listed in Shenzhen and Shanghai.

Three in every four stocks have halted trading since Wednesday, prompting concern some companies are being driven by survival instinct to find a way out of the market turbulence.

Premier Li Keqiang and his government trotted out the big guns over the weekend to try to stop the carnage, including ordering a halt to initial public offerings and ramping efforts to restore liquidity by getting pension funds to throw money at the problem.

Twenty-one major securities brokers responded by pledging to invest no less than 120 billion yuan (US$19.33 billion) in exchange traded funds that track blue chips.

Also, these brokerages will not sell their holdings as long as the Shanghai Composite Index is below 4,500 points.

Still, the free-falling market isn't budging and the floor is nowhere in sight.

It seems that the government’s "bazooka" intervention has actually made things worse.

Shen Yi, a former Goldman Sachs trader who now runs his own onshore fund was philosophical about it.

“It's not a financial crisis but a liquidity crisis," he told Yicai.

“When the futures market trades at a heavy discount to the stock market, it indicates the problem is largely solved.”

In order to prevent more losses, the China Financial Futures Exchanges capped the daily trading limit in the CSI 500 futures index at 1,200 lots.

Also, the futures regulator raised the margin requirement for sell orders on futures to curb speculation.

Shen thinks the biggest problem with the A-share market is that investors cannot hedge their stocks by short selling futures.

They're not getting balanced information, so they choose to cash in no matter what, he said.

And the government is using the wrong strategy.

It's trying to stabilize the market by buying into blue-chip stocks.

However, small and mid-sized stocks continue to experience heavy selling pressure, resulting in panic selling by individual investors, he said.

Instead of buying blue chips, the government can stabilize the stock market by using the leverage effect of the futures market.

If there is a certain target support level, the government can keep buying futures whenever the index drops below that level.

That will send a clear signal that it's serious about restoring market confidence.

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EJ Insight writer