July 2015
Asian Equities Team, Schroders
The recent sharp declines in Chinese stock prices have been met with a spate of government counter-measures aimed at supporting the market.
Back in May, we discussed our thoughts on the liquiditydriven rally in China’s A-shares and how valuations of
Chinese companies were not justified by the underlying fundamentals. We also expressed our concerns that
A-shares were already at vulnerable levels in light of their frothy valuations, increasing IPO issuance, rising margin financing and deteriorating corporate fundamentals.
What market watchers did not know was when the meteoric prices would come crashing back to reality.
Recent market falls suggests that moment has now arrived and investors realise that the current government measures aren’t going to help ignite a rebound rally.
What goes up…
So what sparked this year-long surge in prices that saw the market peak at a seven year-high on 12 June?
These came down to four main factors. These were the ‘bad news is good news’ catalyst, whereby weaker
Chinese data was expected to trigger policy easing and broader macro stimulus; a significant increase in leveraged trading; supportive government policies such as interest rate and RRR cuts; and finally market momentum. These all combined to see a strong liquidity-driven rally in Chinese A-shares over a 12-month period.
…must come down
Since hitting a multi-year high on 12 June, Chinese A-shares markets have been in freefall and have since declined nearly 30%. More than 50% of the listed stocks on China’s two main exchanges, Shanghai and
Shenzhen, have now been suspended as of 8 July.
What drove the bubble in A-shares to burst? Firstly, the recent run-up in share prices was fuelled not only by broker margin financing but also by other informal financing channels. The data on broker margin financing, which peaked at about 2.2 trillion renminbi (RMB, as of mid-June), is more transparent and well-known to the market. Other than that, there are other types of informal financing channels, such as so-called umbrella trusts issued by banks and other private lending.
There was also the increased issuance of IPOs, with some mega listings taking place in June – further draining liquidity from the market. Insider selling and company placements also hit sentiment as listed companies’ major shareholders/management cumulatively sold a total of RMB 400 billion worth of shares year-to-June, which is an unprecedented volume in A-share history.

Schroders Talking Point Page 2
How has the government reacted?
China’s government has responded to these declines via a number of measures which it hopes will stem the selling. T he China Securities Regulatory Commission (CSRC) announced that it would ‘uphold market stability’ by providing liquidity to China Securities Finance (CSF), a state-owned entity that makes margin financing available to brokers. In addition, a number of brokerages launched an RMB 120 billion fund to help support the market by jointly investing in blue-chip exchange-traded funds (ETFs).
The government has also cut transactions levies, suspended new short positions and encouraged brokerages to relax their margin enforcement level. Authorities have further encouraged shareholder buybacks and restricted major shareholders from selling in the next six months.
A suspension of IPOs has also been announced, in an attempt to shore up liquidity in the secondary market while share buybacks have also been used by companies as a tool to instill confidence in the markets. These measures have come in part from previous experiences of market cycles, particularly in Hong Kong, during the
Asian Financial Crisis when the central bank used its foreign exchange reserves to defend the peg Hong Kong dollar/US dollar peg, and Taiwan, where the government also previously set up a central market stabilisation fund.
How about Hong Kong’s H shares?
The deleveraging currently ongoing in China’s A-shares markets will likely trigger selling in mid-cap stocks in
Hong Kong. Broader Hong Kong ‘blue chip” names have been less volatile. In general, the Hong Kong stockmarket is more institutionalised and less prone to wild swings in volatility. The Hong Kong market lagged the China A-share market rally in the first half of this year, as the share price discount of dual-listed China companies widening compared to their A-share counterparts during the period.
In the near term, the MSCI China will continue to be influenced by the market sentiment seen in A-shares as well as external market factors, including a potential ‘Grexit’ in the eurozone. As Hong Kong-listed China stocks have not seen their share prices soar as much as their A-share counterparts, they have recently corrected to more reasonable valuations and provide an opportunity for long-term investors to accumulate quality names. The MSCI China now trades at 1.3x trailing P/B, close to one standard deviation from its
10-year average.
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