Shanghai Composite Sinks Toward 3,500 as State-Backed Gains Fade

Chinese stock traders put the government’s market rescue to the test, sending the Shanghai Composite Index to within one point of its low during the depths of a $4 trillion selloff last month.

The benchmark index dropped 4.3 percent to 3,507.74, clawing its way above the 3,500 level in the last five minutes of trade. With data Friday showing the manufacturing sector is at the weakest since the global financial crisis, investors are trying to gauge how far state-linked funds will go to prop up share prices. Hong Kong’s Hang Seng Index entered a bear market after dropping more than 20 percent from its April 28 peak.

China’s first major economic indicator for August signaled a further deterioration in growth prospects as the preliminary Purchasing Managers’ Index from Caixin Media and Markit Economics trailed analyst estimates. Chinese equity funds were the biggest contributors to more than $4 billion of outflows in Asia excluding Japan in the week to Aug. 19, EPFR Global said.

“Government intervention isn’t going to change the market correction in the long run,” said Ken Chen, an analyst at KGI Securities Co. in Shanghai. “The market won’t trend up until the valuation bubble is totally erased.”

Signs of state buying have appeared around the 3,500 level at least five times over the past six weeks. Speculation around the government’s intentions has escalated since last Friday, after the securities regulator signaled authorities will pare back an unprecedented campaign to prop up share prices as volatility falls.

Officials have armed a state agency with more than $400 billion to stop a $4 trillion rout. It also banned selling by major shareholders and told state-owned companies to buy stocks.

Stock Valuations

Even after the declines, Chinese shares remain expensive relative to global peers. The median stock on mainland bourses trades at 62 times reported earnings, higher than any of the 10 largest markets, according to data compiled by Bloomberg.

The Hang Seng Index dropped 1.5 percent. The Hang Seng China Enterprises Index of Chinese stocks in Hong Kong slumped 2 percent, capping its biggest weekly loss since 2011. The Shanghai Composite closed below its 200-day moving average for the first time in a year.

The preliminary manufacturing index for August fell to 47.1, the lowest since March 2009, compared with the 48.2 estimate in a Bloomberg survey of analysts. A number less than 50 signals a contraction.

“The very weak private sector PMI shows that smaller Chinese enterprises are facing a challenging environment to expand activity,” said Bernard Aw, a Singapore-based strategist at IG Asia Pte. “It points towards the narrative that we could see a further slowdown in China. That is worrying for the global economy.”

Foreign Outflows

As the state battles to prop up stock prices, investors with the most at stake are cashing out.

The number of traders with more than 10 million yuan ($1.6 million) of shares in their accounts shrank by 28 percent in July, while those with between 1 million yuan and 10 million yuan declined by 22 percent, according to data compiled by the nation’s clearing house. International investors have sold more than $7 billion of Shanghai shares through an exchange link with Hong Kong since July 3.

Technology and consumer shares were the biggest decliners on the CSI 300 Index on Friday, which lost 4.6 percent. Shanghai Wangsu Science & Technology Co. plunged 9.1 percent. BYD Co. tumbled 4.1 percent, while Dongfeng Motor Group Co. slumped 5.6 percent.

Currency Decline

A weaker yuan is also reducing the attractiveness of Chinese assets. The currency dropped as much as 0.17 percent to 6.3899 a dollar on Friday, following last week’s 2.9 percent depreciation. The cost of one-year interest-rate swaps, the fixed payment to receive the floating seven-day repo rate, slipped three basis points to 2.58 percent.

More than 62 percent of companies in the Shanghai Composite trailed analysts’ 2014 earnings estimates as the economy expanded at its weakest pace since 1990. Profits at Chinese industrial firms declined by 0.3 percent in June, versus a 0.6 percent gain in the previous month.

“The economy continues to be on a downward trend and it’s not likely to pick up soon as there’s no clear driver for growth,” said Wei Wei, an analyst at Huaxi Securities Co. in Shanghai. “The stock market may drop further to seek a lower support. Short-term sentiment is pretty weak.”

— With assistance by Shidong Zhang, and Cindy Wang