China $550 Billion Stock Wipeout Reminds Traders of 2007 Catastrophe

Chinese Stock Markets

Chinese Stock Markets

The rout wiped out about $350 billion of market value in a week on the Shanghai and Shenzhen exchanges. It so traumatized traders that eight years later they still refer to the decline by the date it began: the 5/30 catastrophe.

The milestone for the modern Chinese stock market, which began in 1990, started on midnight, May 30, 2007, with Hu Jintao’s government unexpectedly announcing it would triple a tax on stock trading. The plunge sparked by the pronouncement had followed a breathless rally, making it eerily similar to last week’s events.

On Thursday, stocks erased almost $550 billion in value after surging 143 percent on the Shanghai Composite Index over the past year. Traders could be forgiven for a wave of deja vu mixed with a dollop of dread: In 2007, stocks recovered from their May losses only to drop more than 70 percent over the next 12 months from an October peak.

The Shanghai Composite gained 4.7 percent at the close Monday, its biggest gain in four months.

Here’s a look at the similarities and differences between China’s markets then and now.

What’s similar:

* Timing of declines: Both selloffs followed rallies that sent the benchmark index up more than 100 percent in just months.

Thursday’s tumble in Chinese stocks came after brokerages tightened lending restrictions and the central bank drained cash from the financial system. The Shanghai Composite shed 6.5 percent and fell another 0.2 percent in volatile trading on Friday.

On May 30, 2007, the Shanghai gauge also tumbled 6.5 percent after the government raised the stamp tax to 0.3 percent from 0.1 percent. The measure aimed to cool the stock market after it doubled in about six months and almost quadrupled from the end of 2005.

By June 4, the benchmark had lost 15 percent. The market then started to stabilize and rose another 66 percent to an all-time high in October 2007 before tanking again as the global financial crisis raged.

* Rookie traders: The two stock rallies were fueled by record amounts of new investors, increasing fluctuations.

About 29 million new stock accounts have opened this year through May 22, almost as many as in the previous four years combined, according to the China Securities Depository & Clearing Corp. Margin debt on the Shanghai exchange has soared more than 10-fold in the past two years to a record 1.35 trillion yuan ($220 billion) on Thursday.

In the first five months of 2007, more than 20 million stock accounts opened, four times the amount in all of 2006. Margin trading, or investing with funds borrowed from brokerages, wasn’t allowed then.

* Initial public offerings: In both instances, a flood of new companies came to the market to take advantage of rising share prices. More than 120 newly listed companies have started trading so far this year, almost matching the total for all of 2014.

In 2007, PetroChina Co.’s 67 billion yuan ($11 billion) IPO was “one of the catalysts” pricking the “bubble,” Hao Hong, the chief China strategist at Bocom International Holdings Co. in Hong Kong, wrote in a note on May 28.

What’s different:

* Monetary policy: China’s economy was booming in 2007, prompting the central bank to extend a policy of raising interest rates for a third year. Higher borrowing costs eventually helped cool the market.

This time, policy makers are cutting interest rates as the economy slows, bolstering stocks. The People’s Bank of China lowered its benchmark for the third time in six months to 5.1 percent on May 11. The central bank will further cut it to 4.85 percent by December, according to economists surveyed by Bloomberg.

* Valuation: While stocks have become more expensive, price-to-earnings ratios are still lower than in 2007. Trading at around 18 times forward profit, the Shanghai benchmark is about 60 percent cheaper than at its at peak of 2007, data compiled by Bloomberg show.

* Liquidity: Unlike in 2007 when the Chinese market was largely off-limits to foreign investors, authorities have recently accelerated the accessibility of stock trading, luring more overseas funds.

A link between the Shanghai and Hong Kong exchanges established in November allowed international investors greater access to the local market. A similar program between Shenzhen and Hong Kong is due to start this year. Global funds investing in China added more than $4 billion in the week through May 27, more than double the previous record set in 2008, according to data provider EPFR Global.

* Government support: Policy makers repeatedly warned investors of risks in the stock market in 2007. This time, they’ve voiced their support. As the government tries to lower corporate debt levels, the equity market has become a more important venue for companies to raise funds, according to Andrew Sullivan, head of sales trading at Haitong International Securities Group in Hong Kong.

By moving money away from the “shadow banking” system, it makes investments “more controllable,” Sullivan said on Bloomberg Television.

“That’s where they want to keep it,” he said.

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