China stocks slump 7% as bull run stalls

Why China's stock rout is a good thing

Chinese stocks slumped more than 7 percent on Friday as markets struggled to digest a wave of new IPOs amid growing bearish sentiment toward what is still one of this year's best performing stock markets.

Trade in Chinese shares has been marked by violent selling in the past two weeks – the Shanghai Composite shed 13 percent last week and further 6.4 percent this week – a sharp contrast to the stellar gains that pushed it to a record high in early June.

Read MoreChina stocks suffer biggest one-day loss in 5 months

"Asian investors have routinely had a short-tem view and that moves them towards extreme volatility up and down," Ken Fisher, founder and CEO of Fisher Investments told CNBC's "Squawk Box Europe." "You've had a heck of a move and in some ways people have treated this like a casino."

The benchmark Shanghai Composite stock index closed down 7.4 percent at 4,193 points, suffering its biggest one-day percentage fall in five months, according to data from Thomson Reuters.

Johannes Eisele | AFP | Getty Images

IPO wave

Analysts cited a wave of new initial public offerings as a reason behind the latest wave of selling.

In fact, Friday saw China's biggest IPO in five years with a $4.85 billion listing from Guotai Junan Securities. The stock surged 44 percent in its debut, drawing interest away from other shares.

Chinese companies have raised $39.4 billion from IPOs so far in 2015, more than double the $17.9 billion raised in the same period last year, according to Dealogic. That new liquidity has diluted the value of the overall market, analysts said.

Read MoreChina's biggest IPO since 2010 makes blockbuster debut

Ben Collett, head of Asian equities at Sunrise Brokers in Hong Kong, said "bankruptcy season" in China may be another reason behind the market volatility.

"It's a seasonally high period of defaults … to some extent, you expect a number of names on every exchange to get suspended…We haven't seen by any stretch a large number of these names. That would make me more nervous, rather than less," he said.

Others saw a sharp sell-off in Chinese stocks as a sign of a bursting market bubble. Even after the correction of the past two weeks, China's stock market is one of the world's best performing bourses and remains almost 30 percent higher in year-to-date terms. It is up just over 100 percent in the past 12 months.

Time to bail?

Stewart Richardson, chief investment officer at RMG Wealth Management, told CNBC on Thursday that he thought China's stock market could fall a further 50 percent, while Morgan Stanley issued a new price target for the Shanghai Composite and forecasts a possible downward move of over 20 percent.

Read MoreWhy Chinese stocks could slide 50 percent

In a research note, the U.S. bank set a new mid-2016 range for the Shanghai Composite of 3,250-4,600, down from a prior end-2015 target range of 4,000-4,800.

"Our stance on China A shares is that this is probably not a dip to buy. In fact, we think the balance of probabilities is that the top for the cycle on Shanghai, Shenzhen and Chinext has now taken place," the Morgan Stanley note said.

"We remain concerned over four factors: a) increased equity supply, b) continued weak earnings growth in the context of economic deceleration, c) high valuations, and d) very high margin debt to free float market capitalization," it added.

Other analysts remained a bullish note, with Sunrise Brokers' Collett noting that the slide in Chinese shares on Friday paled in comparison to the scale of their gains this year.

"This is nothing. It's one of the fireworks in a really big fireworks show," he said, tipping the Shanghai Composite a buy at 3,800.

- CNBC's Leslie Shaffer and Ansuya Harjani contributed to this story.

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