China Turns to Market-Boosting Playbook That BofA Calls Obsolete

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Bank of America Corp. strategist David Cui has a laundry list of support measures that China’s government might deploy to fight the steepest stock-market rout since 1996.

They could halt initial public offerings, encourage insurers to buy shares, ease access to margin financing, reduce stamp duties or cut lending rates -- just to name a few.

The problem for bulls, Cui says, is that none of those measures is likely to spark a sustained rally at a time when margin traders are unwinding a record build-up of leveraged bets. His year-end target for the Shanghai Composite Index implies a drop of 11 percent from Monday’s close.

“The margin call, forced sale, margin call vicious cycle can quickly develop a momentum of its own,” Cui, the head of China equity strategy at Bank of America in Singapore, said in an e-mail on Monday.

Doubts about policy makers’ ability to prop up the world’s second-largest stock market are spreading after a weekend interest-rate cut and speculation that regulators will halt IPOs failed to prevent the Shanghai Composite from tumbling into a bear market. The gauge would need to fall a further 13 percent to match its average downturn since 1990.

“Any support the government can provide would be short lived,” Chad Padowitz, the Melbourne-based chief investment officer at Wingate Asset Management Ltd., said by phone. “The only real support they can provide over time is providing a reasonably balanced, growing economy. That’s the best thing they can do. Anything they do short term, decreasing interest rates to support the market or things like that, are somewhat foolish.”

Borrowed Money

The increasing role of leverage in Chinese stock trading is making it especially hard for authorities to control swings in what’s become the world’s most volatile market after Greece, according to Paul Chan, the Hong Kong-based chief investment officer for Asia ex-Japan at Invesco Ltd.

Margin debt on the Shanghai Stock Exchange fell for a sixth day on Monday to 1.36 trillion yuan ($219 billion), the longest stretch of declines since June 2014, while the benchmark gauge’s 10-day volatility reading jumped to the highest since 2008. A five-fold surge in leveraged wagers had helped propel the Shanghai index to a more than 150 percent gain in the 12 months through June 12.

“Nobody knows when the market will bottom as the unwinding of margin financing makes it very difficult to forecast,” Chan said. “It is very difficult to control the capital markets.”

‘Lost Faith’

The Shanghai Composite jumped 5.5 percent at the close on Tuesday, reversing an earlier 5.1 percent plunge.

Zhang Xiaoxi, a 29-year-old designer in Chongqing, says there’s nothing the government can do to convince her that stocks are a safe bet.

“I’ve lost faith,” Zhang, who liquidated her 20,000 yuan investment in shares last week. “With the policy catalysts, the government is just creating a false illusion that the bull market hasn’t ended. It might introduce further measures or policies, but they won’t have much effect as people have started to shift their funds to other channels, including property.”

Not everyone is so pessimistic. Huang Haiqiao, who works in the finance industry in Hangzhou, is sitting tight on his more than 100,000 yuan of equity holdings.

“The government is clearly trying to prop up stocks,” he said. Policy makers “will take further steps, including cuts in interest rates and reserve requirement ratios, allowing social security funds to invest in stocks and possibly lowering the stamp duty.”

Suspending IPOs

Chinese regulators are considering suspending IPOs in an attempt to stabilize the market, people familiar with the matter said Monday, asking not to be identified as the regulator’s deliberations are private. China Securities Regulatory Commission officials didn’t respond to a faxed request for comment.

History suggests the move -- designed to head off any diversion of funds from existing shares into new listings -- may do little revive the market. The last three times the regulator suspended IPOs in the past decade, the Shanghai Composite fell an average 8.6 percent in the following four weeks. It gained just 3.1 percent over six months, according to data compiled by Bloomberg.

The Shanghai gauge may fall as much as 14 percent from current levels before it bottoms out, according to Hao Hong, the China equity strategist at Bocom International Holdings Co. in Hong Kong.

Misplaced faith in policy makers’ ability to limit losses proved an expensive lesson for investors during China’s equity bubble in 2007, Jonathan Garner, the head of Asia and emerging-market strategy at Morgan Stanley in Hong Kong, wrote in a June 26 report.

No Control

While bulls argued that China wouldn’t allow a stock-market crash before the Beijing Olympics in August 2008, the Shanghai Composite sank 57 percent from its peak through the day of the opening ceremony. The benchmark index has dropped 35 percent on average in bear markets since 1990, compared with the current slide of 22 percent from its June 12 high.

“Our general view is that governments are not able to exert direct control over stock market behavior,” Garner wrote. “In particular where trading volumes, valuations and margin leverage are as stretched as they are now in China.”

— With assistance by Allen Wan

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