It ain’t over til it’s over.
Chinese equities dropped 20% from its June 12 peak Monday, marking its entry into bear market territory. Though the market rebounded Tuesday with a 5.5% gain at the close, some strategists such as David Cui, Tracy Tian and Katherine Tai of Bank of America Merrill Lynch believe the market has probably seen its peak.
Chinese stocks have been falling recently — even before Monday’s bloodbath, which was a reaction to reports that Greece and its creditors failed to agree on a debt relief package over the weekend — due to tighter margin financing, which helped investors purchase stocks.
On Monday’s rout, some margin calls have been made, adding more downward pressure on the market besieged by panicking investors.
“We doubt that this marks the end of the de-leveraging process in the stock market given that much of the leveraged positions are yet to unwind. We believe that the chance is high that we have seen the peak of this round of rally in the A-share market,” the BofA Merrill Lynch strategists wrote in a note released late Monday, after the close of China’s stock market.
What makes margin financing in China more complicated and riskier is the availability of funds outside of the official channel. Other than the margin financing facilities (MFs) offered by brokerages, Chinese investors could borrow from umbrella trust, financing firms, P2P (peer-to-peer) platforms, among others.
“These leverages are more risky than MFs because they are less transparent and lightly regulated, if at all. For example, anecdotally, we saw many cases of 10 times leverage versus less than 1x at MFs; and also unlike MFs, the other borrowings are often used to buy small caps, which tend to be more speculative,” the note said.
China’s securities industry association on Monday tried to downplay the impact of margin positions in the market saying that they have been quite small versus total market trading volume, Reuters reported.
BofA Merrill Lynch said this is still a cause for concern. Their strategists wrote:
“The selling pressure right now has mainly come from stock-related borrowings via various unofficial channels where the leverage is much higher. Besides, sentiment plays a decisive role. If many leveraged buyers believe that the bull market is over, they may be inclined to sell due to the high interest cost burden.”
It is interesting to note that before Monday’s crash, the Chinese government tried its best to calm investors by announcing a 25bps reduction on its key rates, and a 50bps cut on the reserve requirement on bank deposits. Media reports said it was the first time that the central bank, the PBOC, simultaneously reduced its policy rates and the reserve requirement ratio since October 2008, or during the financial crisis, suggesting the intensity of the impact of the Greek debt crisis on the now fragile market.
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