Beijing’s market invasion comes at a cost

CNBC

Aggressive policy action is now a regular feature of global markets — Haruhiko Kuroda had his bazooka, while Ben Bernanke took to a helicopter.

But in China, falling asset prices have been met with a full-scale invasion of the market, securing an expensive victory that many believe could yet prove fleeting.

Following three months of massive government intervention to halt diving stocks, Chinese authorities appear ready to declare their mission accomplished. Zhou Xiaochuan, governor of the People's Bank of China, told a G20 meeting last weekend that the stock market correction, which has left the Shanghai Composite nearly 40 per cent below its June high, is now "mostly over".

In the days since, the Shanghai Composite has barely budged, rising 1.2 per cent this week. Having tumbled from a peak of 5,100 points in mid-June, the index seems to have found a new comfort zone just above 3,000 points, where it has been trading since the last week of August.

Domestic analysts have been quick to express their relief. "Given that recent policy measures have restrained speculative activities and deleveraging has run its course for the time being, there is hope for a market rebound," says Wang Fen at Shanghai Securities. Meanwhile, Soochow Securities has released a report entitled: "The severe winter is past, and the time has come for spring planting."

Not everyone is convinced, however. Average equity valuations may have come down significantly from the peak, but many stocks — especially small-caps — still trade at price to earnings ratios far above their historical trend. Despite the huge falls in the Shanghai and Shenzhen indices, both have risen a third over the past 12 months, making them the best performing markets in the world. The bubble, say the sceptics, has not yet completely burst.

"The government is supporting the market at too high a level", says Francis Cheung, China equity strategist at CLSA. "They are going to lose. At some point, they will have to let go." He has a price target for the Shanghai Composite of 2,700, implying a further 15 per cent drop from current levels.

Even if Beijing has succeeded in putting a floor under share prices, it has done so at great expense. The government itself has deployed as much as Rmb1.5 trillion ($236 billion) to support the stock market in the past three months, according to estimates from Goldman Sachs.

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The costs of rescuing the market have not just been financial. The intervention has derailed some key reform initiatives, such as shifting capital raising from commercial bank loans to the equity market. To cut the supply of new shares into the market, initial public offerings have been frozen.

Trading volumes have collapsed as government action, capital outflows and ructions in the currency markets have sapped liquidity. Turnover on the Shanghai stock exchange on Tuesday fell to $43 billion, the lowest daily amount since February and down from a peak of $212 billion in early June. Futures volumes have taken an even more severe hammering.

"Futures are dead, options are dead, margin finance is dead. Brokers are unwilling to lend, so there's no liquidity", says Hao Hong, strategist at Bocom International. "Effectively, they closed down the market."

Meanwhile, the longer term goal of increasing foreign participation in domestic financial markets has taken a significant step backwards after new rules were introduced that banned short selling and big share sales.

"Nobody wants to own an asset without knowing if they can sell," says Bob Browne, chief investment officer at Northern Trust, the US fund manager with $960 billion in assets under management.

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Investors and brokers have also found themselves under investigation by the authorities. The sweeping probe into market malpractice, seen by some as a witch hunt, has spooked many fund managers even more so than the sharp stock price declines.

And despite official declarations that the crisis is over, many believe there is further to fall, especially with the economy continuing to slow. Though consumer inflation has started to tick higher on the back of rising pork prices, factory gate prices are still falling sharply, while trade growth remains tepid.

"Even after the plunge, we haven't really capitulated. It is very difficult to say we have bottomed out and fundamentals aren't getting better," says Mr Hong. "What's the reason to buy?"