The Chinese stock market meltdown is accelerating despite government intervention and is blowing back to commodities markets, including copper and oil, which are trading down based on concern that the stock market plunge is a harbinger of even more economic weakness. The Financial Times gives a snapshot of today’s downdraft:
China’s central bank stepped up state support for sinking stocks on Wednesday, as investors rushed to sell what they still could after a fresh wave of share suspensions that have now halted trading in half the market.
The Shanghai Composite opened down as much as 8 per cent before paring losses to a 4.7 per cent decline by 11:15am local time. The Shenzhen index lost 3.3 per cent, while the start-up ChiNext board was down 0.2 per cent.
The renewed selling followed another round of share suspensions overnight, which have now halted trading in 1,476 stocks — or more than 50 per cent all listed companies on China’s two main exchanges. The suspensions have frozen $2.6tn worth of equity, according to Bloomberg calculations.
But even with the dramatic declines of recent days, and orders still so lopsided that trading in more than half the stocks on China’s two biggest exchanges has been suspended, China’s stock were on such a tear this year that they still have yet to give up this year’s gains As the Wall Street Journal points out, “Despite the recent tumble, China’s main stock index is up 72% over the past year and 10% since January.” But it is Not a Good Sign that the market hasn’t stabilized even in the face of central bank intervention. The financial press is using words like “panic” to describe investors’ mood, and the selling has spread to risky bonds.
It is important to understand that the significance of a stock market plunge depends both on how big the bubble got before it burst, but even more important, how much of the bubble was the resulted from levered speculation. The Roaring Twenties frenzy was fueled substantially by borrowing, often through trusts, which allowed for tremendous leverage (trusts investing in trusts). After the Crash, the US put curbs on margin lending, with the result that the 1987 and dot com busts didn’t blow back to the financial system or the real economy in a major way.*
And we don’t have very good answers for China. One of the notorious features of the economy is the lack of reliable data. Even though margin lending is high by US standards, 4.4% before today’s fall, it’s vastly below the amount of gearing in the US stock market before the Great Crash. Value Walk (hat tip Lambert) puts margin debt at 8.5% of free float, which is a troublingly high level. Ruchir Shama, the head of emerging markets and global macro at Morgan Stanley, similarly estimates margin lending at close to 9%, which he calls “the highest in any market in history.” Moreover, there is no way of knowing the degree to which the money that went into stock buys was from borrowings other than margin loans, say by borrowing against real estate. So a big loss in the stock market could lead to later defaults on other loans.
The Wall Street Journal on Monday explained why the Chinese stock market implosion is a bigger deal than it seems on the surface:
Stock ownership in China is still quite limited, and the individual accounts that dominate trading are small. In fact, the only real losses so far have been among stock investors who arrived late to the party. Economists argue over whether a full-scale collapse would have much impact on the overall economy.
Yet the government’s response revealed an urgent—some say panicked—impulse not only to protect investors but to shield the party from criticism and head off possible social unrest.
The ultimate goal of Chinese security is weiwen, or “stability maintenance,” which is another way of saying “maintaining party rule.”
And that view led to the extreme measures taken so far. From the same article:
In that sense, the unprecedented rescue moves, including a multibillion-dollar fund set up by Chinese brokerages at the government’s behest to buy blue chips, is a preview of what’s to come following the passage last week of a national-security law that massively expands the definition of threats to the state to cover almost every aspect of domestic life, including “financial risk,” as well as international affairs. The law explicitly states that economic security is the foundation of national security.
Today, Sharma argued in a Wall Street Journal op-ed that China’s Stock Plunge Is Scarier Than Greece. Key sections:
China’s state-sponsored stock-market rally is unraveling, with potentially dangerous consequences. The first major sign that all wasn’t going according to script came on June 15. Chinese had awakened expecting big gains because it was President Xi Jinping’s birthday, but the Shanghai market fell more than 2%…..
In most countries, no one thinks there is a link between a leader’s birthday and the market. That such a theory prevails in China reflects the widespread belief that Beijing’s authoritarian government can produce any economic outcome it wants. Now trust in China’s ability to command and control the economy is faltering. If trust collapses, the global repercussions could be more severe than those from the Greek debt crisis.
Yves here. If that was the sentiment behind China bullishness, it clearly chose to ignore all sorts of warning signs, the biggest being massive overinvestment in economically unproductive real estate. And worse, this bubble looks to be a rerun of the fatal Japan stock/real estate market bubble, where the central bank in each case sought to goose asset prices to boost consumption and investment. Again from Sharma:
Funneling some of China’s $20 trillion in savings into stocks was a last-ditch effort to revive flagging economic growth by giving the country’s debt-laden companies a new source of financing. The aim was to trigger a slow and steady bull run, but the somnolent stock market exploded into one of the biggest bubbles in history.
And the worst sort of rubes piled in:
Today China’s 90 million retail investors outnumber the 88 million members of its Communist Party. Two thirds of new investors lack a high school diploma. In rural villages, farmers have set up mini stock exchanges, and some say they spend more time trading than working in the fields.
The signs of overtrading are hard to exaggerate. The total value of China’s stock market is still less than half that of the U.S. market, but the trading volume on many recent days has exceeded that of the rest of the world’s markets combined.
We haven’t written about China for quite a while, but our position has long been that it would be extremely unlikely that China could avoid either a long period of sub-par growth (which would be a cause of political and social stress) or a serious dislocation. No significant economy has made a smooth transition from being investment led to being consumption led. But worse, China doubled down on its old economic growth model by pursuing policies that generated even more investment. Even though China’s dependence on exports as a source of growth diminished somewhat, the importance of investments grew. to the point that export plus investment share exceeded 50% of GDP. Some pundits pointed out that the marginal productivity of borrowing was falling, another danger sign. But as long as the old model seemed to be working, it made no sense, at least if you were an investor, to fight the tape. Again from Sharma:
Looming over all of this is China’s massive run-up in debt, which has increased by over $20 trillion—to around 300% of GDP—since the global financial crisis in 2008. All along, the bulls argued that Beijing has successfully managed every challenge to its three-decade economic boom, and that it could overcome the threat this debt represents. At a minimum, the argument went, China’s financial woes would be smaller than those of other countries with high levels of borrowing. This faith in Beijing encouraged many global hedge funds to pile into Chinese stocks.
But if Beijing can’t stop the market’s tumble, there could be a sudden shift in the perception of exactly how far economic growth might fall under the weight of too much debt. If that floor crumbles and the Chinese economy spirals downward, it will make the drama surrounding Greece feel like a sideshow. China has been the largest contributor to global growth this decade; Greece’s economy is about the size as that of Bangladesh or Vietnam.
Sharma is choosing to ignore the longer-term implications of the immolation of Greece for the future of the Eurozone, but he’s right about China’s importance to global growth, particularly for commodities producers. The Sydney Morning Herald (hat tip EM) describes some of the knock on effects so far:
The stockmarket rout has also comprehensively choked off a slight recovery in the prices of commodities like iron ore and oil, dragging down shares in resource giants BHP Billiton, Rio Tinto and Fortescue, as well as the currencies of producing nations like Australia and Canada.
Iron ore had recovered to more than $US60 a tonne from a decade-low of $US47 in April. By Tuesday, it had dipped below $US50 after consecutive days of sharp declines.
The fall in iron ore comes as construction demand in China falters and the overwhelming majority of the country’s steelmakers sit deeply in the red. Even still, major miners continue to increase shipments to China, contributing to a glut of supply and mounting stockpiles at major iron-ore ports, all while confidence is being battered by China’s free-falling stockmarket.
In further bad news for steel demand, Chinese automakers are reporting a major dent in sales, describing last month as the “worst June ever”.
Fortescue, among others, have previously cited China’s surging long-term demand for cars as a key to filling in the gap in the demand for steel vacated by slowing construction in China.
“The plunging stock market is essentially a meat grinder, shredding money meant for buying cars,” Cui Dongshu, the secretary-general of China’s Passenger Car Association told Bloomberg.
He said an increasing number of car buyers in China are canceling their purchases and risking forfeiture of their down payments.
China maven and long-term skeptic Michael Pettis thinks the officialdom has 80% odds of being able to engineer one more big stock market rally. US crisis followers will recall that our tsuris had three acute phase before the final Lehman-triggered cataclysm. It’s not obvious how China could engineer a soft landing. Propping up unsustainable financial and economic models generally leads to nasty unravellings.
Update 3:00 AM: Bloomberg published a new story after I started drafting this post. The stock market suspensions are now up to 71%:
Investors looking to sell Chinese shares have found themselves locked out of 71 percent of the market…
“The latest development of trading halts will affect investor confidence,” said Bernard Aw, a strategist at IG Asia Pte Ltd. In Singapore. “Individual traders will still offload the counters when trading resumes, unless there is a considerable change.”…
The selloff is defying increasing efforts by officials to restore confidence. China Securities Finance Corp. — which manages the nation’s short selling and margin trading — is seeking at least 500 billion yuan ($80.5 billion) to shore up equities, people familiar with the matter said Wednesday. The central bank said the same day it would provide “ample liquidity” to the market. Margin requirements were raised on small-cap index futures, while state-owned companies were ordered not to sell shares.
The authorities have “not only failed to stabilize the market, they have actually increased panic levels,” Alex Wong, Hong Kong-based asset-management director at Ample Capital Ltd., which oversees about $129 million, said by phone. “We are reducing exposure, raising cash levels and trying to stay out of the market.”
*However, the 1987 crash was more touch and go than you might imagine. The Chicago MERC almost failed; it was saved only with a three minute margin by Continental Illinois CEO Tom Theobald being in the office early and overriding an internal (and procedurally correct) order to not fund a $400 million loan against a failed customer order. John Phelan, head of the NYSE, said if the MERC hadn’t opened, the NYSE would not have opened, and if it has closed, he was not sure it would have been able to reopen. The US Treasury market dried up to the point where the Fed called the Bank of Japan and told them to start buying Treasuries. The BoJ called the major Japanese banks who dutifully complied. The fact that the panic then impacted the Treasury market negatively is a big contrast with behavior today; market panic lead to a flight to quality and Treasuries are seen as a safe haven.