Last updated: June 25, 2013 5:58 pm

Shanghai shaken by unease over China policy

Anthony Bolton may yet regain his reputation for timing. Since the veteran Fidelity stockpicker announced his retirement from the company’s China fund last week, the Shanghai market has plunged more than 9 per cent, falling into bear market territory.

The main Chinese index saw more wild swings on Tuesday, falling as much as 5.8 per cent at one point before bouncing back in late trading. That compounded investor jitters caused by a 5.3 per cent loss the previous day.

The speed of the selling may be new, but the negativity surrounding the market is not. Chinese stocks are comfortably the worst performers in Asia this year to date, and on an annual basis things look even worse. In the past 12 months, the CSI 300 – an index of shares listed in Shanghai and Shenzhen – has fallen 14 per cent. During that period, the Nikkei 225 is up 44 per cent, the S&P 500 has risen 18 per cent and the FTSE 100 has gained 9.4 per cent.

Chinese markets are largely closed to foreign capital but many mainland companies have Hong Kong listings, which are open to global investors. Market falls there have also been notable, with the Hang Seng China enterprises index of mainland stocks losing 8.8 per cent in the past five days.

“There’s a lot of panic in the market,” says Erwin Sanft, China equity strategist at Standard Chartered. “China is a policy-driven market. The signals the government puts out have a big impact.”

Those signals have been the greatest cause of nervousness in recent days. Interbank lending rates spiked as high as 25 per cent last week while the People’s Bank of China, the central bank, stood on the sidelines and warned commercial banks to get their loan books in order.

Despite attempts to cool credit growth, lending has risen rapidly again this year, continuing a trend that began back in early 2009 when the central government launched a massive stimulus programme to combat the effects of the global financial crisis.

Many small and midsized lenders are heavily reliant on the wholesale markets for funding and are exposed to the country’s shadow financing system, which the authorities are keen to bring under control by forcing banks to match assets and liabilities. But those efforts are now having a knock-on effect on the stock market.

The recent jump in lending rates has helped boost returns on wealth management products offered through the shadow banking system, attracting funds from retail investors looking for better returns. Meanwhile, banks and fund managers have been forced to liquidate equity holdings to raise cash, something which may continue.

“I don’t think the liquidity shortage is going to ease any time soon. The PBoC looks pretty resolved this time. Someone in Beijing has made the decision to rip the Band-Aid,” says Howhow Zhang, head of research at Z-Ben Advisors.

“The volatility in the stock market is just a ripple effect. It’s a sign that this shock wave is expanding into the actual economy. I think the pattern will persist for some time. Everybody will be forced to deleverage. People will just continue selling equities and bonds until they feel more comfortable with this new normal.”

Valuation is extremely attractive . . . It’s almost as if the regulators are holding back the share prices for us. I would think this week is the interim bottom

- Wendy Liu, head of China equity research at Nomura

Financial stocks have been among the worst hit in recent trading. China Minsheng Bank has lost 18 per cent in the past five days alone, while even big state-backed lenders like Bank of China have fallen more than 10 per cent. But all sectors have suffered amid concerns that the stress could spread to the rest of the economy. PetroChina is down 13 per cent in June, while China Shenhua Energy has lost 14.5 per cent.

Analysts at ANZ say they expect the liquidity squeeze to last into late July, with the risk of a “hard landing scenario” if it proves to be prolonged.

Meanwhile, confidence in the Chinese economy has been sliding. HSBC last week cut its full-year growth forecast for both this year and next to 7.4 per cent, while Goldman Sachs, Barclays and Morgan Stanley have also lowered their projections.

The global move away from emerging markets has also taken its toll. Last week alone, investors withdrew $558m from China funds, and $521m from pan-Asia funds, according to data providers EPFR.

Despite the bad news, some analysts say valuations are now too compelling to ignore. On both a price to earnings and a price to book basis, Chinese stocks have not been this cheap since the height of the Sars outbreak in 2003.

The Hang Seng Enterprise index now trades at 7.3 times forward earnings and 1.1 times price-to-book.

“Valuation is extremely attractive and bear in mind this is forced selling because of the regulatory-driven liquidity crunch. It’s almost as if the regulators are holding back the share prices for us,” says Wendy Liu, head of China equity research at Nomura. “I would think this week is the interim bottom.”

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