Chinese stocks sank the most in five months, leaving the benchmark index on the cusp of a bear market, after leveraged investors cut holdings and Morgan Stanley joined a chorus of analysts warning that shares are too expensive.
The Shanghai Composite Index fell 7.4 percent to 4,192.87 at the close, bringing its drop from this year’s high to 19 percent. Chinese stock-index futures tumbled by the 10 percent daily limit as investors rushed to hedge their positions, while the benchmark gauge for China’s smaller exchange in Shenzhen sank 20 percent from this year’s peak. A measure of equity volatility jumped to the highest level since 2009.
China’s $8.8 trillion stock market has plunged from first to worst on global performance rankings, threatening to bring an end to the longest bull market since the ruling Communist Party introduced equity trading to the world’s largest population in 1990. Morgan Stanley advised clients to refrain from purchasing mainland shares in a report on Friday, saying the Shanghai Composite’s June 12 high likely marked the top of the rally.
“This is probably not a dip to buy,” wrote Jonathan Garner, the head of Asia and emerging-market strategy at Morgan Stanley in Hong Kong. “In fact, we think the balance of probabilities is that the top for the cycle on Shanghai, Shenzhen and the ChiNext has now taken place.”
The Shanghai gauge has surged 106 percent over the past year as margin debt climbed to a record and investors speculated monetary stimulus will revive the weakest economic expansion in more than two decades. The bull market, which turned 935 days old Friday, is more than five times the average lifespan of previous rallies.
Friday’s rout was led by technology and smaller companies, the leaders of China’s world-beating rally through mid-June. The ChiNext index slid 8.9 percent, extending losses to 27 percent since hitting a high on June 3. The Shenzhen Composite Index also entered a bear market after falling a further 7.9 percent.
The Shanghai Composite’s losses were broad-based with 44 stocks falling for every one that gained. The index slid 6.4 percent this week, adding to a 13 percent plunge last week that was the steepest since the global financial crisis.
The CSI 300 Index of China’s largest companies slumped 7.9 percent on Friday. The Hang Seng China Enterprises Index of mainland companies in Hong Kong fell 2.8 percent and the Hang Seng Index lost 1.8 percent.
With little in the way of economic data or corporate announcements to spark the plunge on Friday, some investors pointed to signs of a pullback by leveraged traders. Outstanding margin debt on the Shanghai Stock Exchange dropped for a fourth day on Thursday to 1.42 trillion yuan ($229 billion).
“The correction is basically margin selling,” said Francis Lun, the chief executive officer at Geo Securities Ltd. in Hong Kong.
The stocks favored most by margin traders at the height of China’s boom in mid-June have since tumbled 26 percent. The benchmark index has had nine straight sessions of intraday swings exceeding 2 percent.
PetroChina Co., the biggest stock in the mainland, slumped 7 percent on Friday. East Money Information Co., the most heavily weighted stock in the ChiNext, dropped by the 10 percent daily limit. Poly Real Estate Group and Gemdale Corp. led declines for developers, tumbling 10 percent.
The stock market is experiencing a “self-correction,” Zhang Xiaojun, a spokesman at the China Securities Regulatory Commission, said at a weekly briefing after the market close. The benefits of reforms haven’t changed and liquidity will remain ample, Zhang said.
Concern over a shortage of liquidity has helped fuel losses this week as investor funds got tied up in new share sales and the People’s Bank of China refrained from easing monetary policy, disappointing some analysts who had anticipated a cut in interest rates or banks’ reserve requirement ratios.
Guotai Junan Securities Co., China’s largest brokerage by revenue, surged 44 percent on its first day of trading in Shanghai on Friday after it completed the nation’s biggest domestic initial share sale since 2010.
“The Shanghai Composite may fall to the 4,000 level in the next five to eight weeks as the government tightens margin lending, new share sales sap liquidity and concern grows the central bank won’t cut lenders’ reserve-requirement ratios,” said Hou Yingmin, an analyst at AJ Securities in Shanghai.
Morgan Stanley cited increased equity supply, weak earnings growth, high valuations and the surge in margin debt for its pessimistic stance, saying the Shanghai Composite may fall as much as 30 percent through mid-2016.
Strategists at BlackRock Inc., Credit Suisse Group AG and Bank of America Corp. all said last week that Chinese equities are in a bubble, while the median stock on mainland exchanges is valued at 85 times earnings -- higher than when the market peaked in October 2007.
— With assistance by Amy Li, and Fox Hu