The 53% rise of the Shanghai Composite Index (SHCOMP) in the 2014 annual exercise made it the best performing major benchmark index in the world, but a rapid increase in the use of margin finance in the mainland equity markets has brought an onslaught of extreme volatility. Despite a sustained bull run over a long period of time, the current fragile state of China’s stock markets has caused analysts to become increasingly concerned and jittery.
The increase in the role of margin finance — jumping thirtyfold over the past three years in Shanghai — has contributed to the amplifying effect on gains and losses. It is important to highlight the divergence between similar national as well as major benchmark indexes, giving us an idea of how large a market correction could be. This divergence is easily noticeable in Figure 1 when comparing the SHCOMP to the Shenzhen Composite (SZCOMP) and Hang Seng Index (HSI).
Identifying the possible reasons
The China Securities Regulatory Commission may have played a role, having granted initial public offering (IPO) approval to a large number of companies, thereby raising more than double the amount that IPOs did during the same period last year. Investors are prone to pull large sums of money before the new listings, so that they can invest when the funds are unlocked again. This batch of IPO approvals has locked up an estimated 6.7 trillion yuan worth of funds, thus reducing liquidity for a short period of time and therefore placing even more pressure on the markets.
However, on a positive note, analysts have for now discarded the volatility contagion effect feared in Hong Kong during the month of April when the Hong Kong-Shanghai link was enabled. The next round of analysis with respect to the influence Chinese A shares have on Hong Kong H shares will come in September when the much expected Hong Kong-Shenzhen link is activated.
With respect to the leverage obtained by Chinese investors via margin financing, there is consensus that a key factor of this Bull Run has been investors being able to drive-up stock prices by purchasing shares on margin. As shown in Figure 2 by analysts at Macquarie Research, margin trading as a percentage of free float shares — in other words, not locked up by the Chinese government — reached a record earlier this year. Such high figures have never been seen in any other market at any time in history.
Another major topic of discussion are lending rates, with the bulls arguing it is only down to the falling interest rates. However the Chinese central bank has maintained its stance on the matter and cut interest rates for the fourth time since November. Many economists expect further easing in the near future, and analysts at UBS are far from feeling comfortable after stating:
“Monetary easing will surely give the impression that monetary policy is being used as a direct response to stock market fluctuations. While this belief can help ensure near-term market stability, the impact on longer-term market health is less clear.”
What the market seems to expect
In the last couple of weeks we have seen statements of all possible types of colours, ranging from those being certain we are in the midst of a bubble period to authorities claiming there is no reason to fear the current red figures. To be even more precise, the Chinese regulating body stated:
“Volatility is a normal status of capital markets… After a reasonable analysis of the current market environment, we find the bullish market logic has not changed yet.”
Such statements aim to dismiss doubts of a major market crash, but of all words the most relevant one might be the last one, “yet”. Recently, we have seen a variety of policy moves such as cutting interest rates to record lows, reviewing margin lending rules and agreements of injecting cash into the economy. With respect to IPOs, regulators have noticed the evident need to hand over IPO approval powers to the respective stock authorities. Such swift interventions have so far not had the impact on the market that many anticipated, but have for now put a halt on the frantic analyst outlooks. The majority of analysts have come to conclusions resembling the one stated by Yang Liu, Chairman & CIO of Atlantis Investment Management. She said in an interview:
“If you look at the big picture, there is no reason for the Shanghai Composite not to go higher but before that we need to lay down the foundations… the correction is just part of a new normal.”
In general, having a high stock market is beneficial for the economy and the Chinese government certainly knows that. But as shown in the past week, the market is volatile and not entirely beneficial to authorities that could eventually lose control of a market correction. The regulators’ actions have been closely monitored by jittery investors, and while analysts no longer expect an immediate end to this healthy correction, few are expecting the Chinese markets to roar out of control.
Breakfast Briefing: Space Race, Google in China and Zuckerberg
Google to Open in Beijing
Alphabet announced that it will open an AI research facility in the Chinese capital yesterday.
Editor’s Remarks: Under CEO Sundar Pichai, Google has been recommitting itself to China after it had most of its services blocked in 2010 when it refused to censor search content. In recent months, the tech giant has been marketing its new TensorFlow AI tools to the Chinese market, which aligns with the state’s ambitions to become a world leader in AI by 2030. Google’s new facility will consist of a small number of AI researchers, supported by hundreds of Chinese engineers. Google expects to face stiff competition for talent given how local tech giants, Baidu and Tencent, are ramping up their own AI efforts.
Telegram Is Not for Sale
Telegram’s elusive founder, Pavel Durov, insists that his messaging service will remain non-profit.
Editor’s Remarks: Durov and his brother Nikolai founded VK, Russia’s answer to Facebook, before they were forced to sell their stakes to a Kremlin-friendly oligarch. The pair has since relocated and built Telegram, an encrypted messaging service that they insist will never be sold. A libertarian – having enabled Telegram users to even send messages that will self-destruct – Durov and his product have gained popularity among cryptocurrency enthusiasts. Durov himself is bullish about the prospects of cryptocurrencies and owns at least 2,000 bitcoins. Pundits, meanwhile, reckon that Telegram is worth in the region of $5bn.
Japanese Space Startup Raises $90m
Ispace Inc raised $90m from Japan’s largest corporates in a bid to reach orbit by 2019.
Editor’s Remarks: Ispace is backed by Japan Airlines, Tokyo Broadcasting System Holdings and also government-backed Innovation Network Corp. of Japan. The company plans to sell advertising space on its spacecraft, which will then feature prominently in distributed images. However, Ispace also envisages the use of rovers that will offer a “projection mapping service”, which will essentially produce a tiny billboard on the surface of the moon. This is the latest announcement in what is rapidly shaping up to be a wider commercialisation of space exploration. Elsewhere, SpaceX and Blue Origin are developing reusable rockets, while Planetary Resources intends to mine asteroids.
Roy Moore Loses Alabama
Moore, who was backed by Trump, narrowly lost to Doug Jones, a largely unknown Democrat.
Editor’s Remarks: Moore’s election efforts appeared to have succumbed to allegations of child abuse that were made against him last week. Newcomer Jones won 49.9% of the vote against Moore’s 48.4% in deeply conservative Alabama, marking the Democrats’ first Senate victory in the state since 1992. Moore is a household name in Alabama but the accusations recently levelled against him have ruined his once impeccable reputation. Reluctant to concede defeat in his home state, Moore has said that Alabama must “wait on God and let the process play out”. Meanwhile, Democrats are jubilant that they have managed to reduce the Republican majority in the Senate to 51-49, which could impact Trump’s tax reform.
Zuckerberg Backs VR Firm
Dreamscape Immersive, a virtual reality (VR) company, is backed by 21st Century Fox, Warner Bros. and Mark Zuckerberg.
Editor’s Remarks: Dreamscape is developing new VR arcades for shopping centres and has just closed a $30m Series B funding round – 50% more than planned. Among its initial backers were Steven Spielberg, 21st Century Fox and Warner Bros. The company has now added to that impressive list the likes of Mark Zuckerberg and Nickelodeon. Dreamscape is capitalising on Hollywood’s interest in VR, which the film industry reckons will draw in greater numbers of viewers and provide an opportunity to raise margins. Dreamscape intends to open seven VR centres in locations across North America and the UK.
Google to Open Artificial Intelligence Centre in China
Google will be opening its first artificial intelligence (AI) research centre in China, despite many of its services being blocked there.
Fei-Fei Li, Chief Scientist of Google Cloud, said:
“I believe AI and its benefits have no borders. Whether a breakthrough occurs in Silicon Valley, Beijing or anywhere else, it has the potential to make everyone’s life better for the entire world. As an AI first company, this is an important part of our collective mission. And we want to work with the best AI talent, wherever that talent is, to achieve it.”
The research centre will focus on basic AI research, and will consist of a team in Beijing, who will be supported by Google China’s engineering teams.
Google’s search engine and its Gmail are banned in China. However, the country has 730 million internet users, making the market too large to ignore.
Google is not the only tech giant facing restrictions in China. Facebook is also banned, while Apple’ App Store has been subject to censorship. In order to comply with government requests, Apple removed many popular messaging and virtual private network (VPN) apps from its App Store in China earlier on this year.
China has recently announced plans to develop artificial intelligence, and wants to catch up with the US. However, human rights groups are concerned by China’s use of artificial intelligence to monitor its own citizens.
Europe Warns Trump on Tax
Finance ministers from Europe’s largest economies have said that Trump’s tax plans breach global agreements.
Europe’s leading finance ministers, including UK chancellor Philip Hammond, penned a letter to the White House in which they raised the possibility of retaliation if the Republicans push on with their tax reforms. Europe is worried that Trump’s “America First” doctrine will undermine global trade patterns and escalate ongoing tensions between the US and its key allies. With the UK looking to its closest ally for support post-Brexit, it is unlikely that Hammond’s latest move will sweeten any future US-UK trade deal. Meanwhile, Trump is unlikely to care about shaking up current trading arrangements, given that he ran for office on the platform of making the US more competitive.
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