Tag Archives: China

the impact of daily price fluctuation limits on Chinese stock trading

July 8, 2015 By in China, emerging markets, Margin, margin trading Tags: , , , , , 3 Comments

As I’ve said in prior posts, I have no desire to buy shares on mainland China’s stock exchanges.  Hong Kong is fine enough for me.

This has led me to not pay enough attention to what may be a key feature of trading there–daily price fluctuation limits of +/ – 10% per day.  What this means in the current context is that a given stock can trade down until it has fallen by the maximum 10%.  Unless/until there are buyers at the -10% level or better, there is no more trade in the stock that day.

While this was common practice in stock markets around the world several decades ago, and is the norm in commodities trading, it is no longer the case in most stock markets.

The reason is that it prevents markets from clearing quickly in times of stress.  It tends instead to increase investor fears and to deepen stock market losses, as well as lengthen the selloff period.  I first saw this very clearly in the cases of Mexico, Spain and Thailand during the market downturn of October 1987.  All three countries had daily fluctuation limits.  After a number of days of limit-down-no-trade, Mexican authorities loosened the bands and the market began to clear.  Spain and Thailand didn’t.  Both markets suffered severe selloffs that lasted for months.

 

Press reports on China have alluded to the daily price fluctuation rule there.  But the authors haven’t a clue as to its significance; they provide no useful information about how it is impacting trading.  They do indicate that many small caps aren’t trading, but that would likely be the case whether price limits were in effect or not.  (Typically, one of the early signs of market recovery is that small caps go down.  The positive signal is that buyers–at any price–have reemerged.)

The 10% rule may be having negative effects on Chinese stock markets. The way to tell would be to examine the most liquid stocks and see if they are closing on the lows, with the last trades significantly before the market close.  Given the behavior of the overall indices and the overall trading volumes, I don’t think this is the case to a crucial degree.  But at this point I’m not curious enough to check.

Even so, it seems to me that Beijing could shorten the period of margin-selling downward pressure on the market if it were to modify or eliminate its old-fashioned daily limit rules.

(a little) more on the Chinese margin crisis

July 8, 2015 By in China, Hong Kong, Margin, margin trading, Stock Connect, stock market Tags: , , , , , , 1 Comment

Chinese stocks closed lower by about 5% overnight, as the margin selling spiral continues downward.

My thoughts:

–this very strongly suggests that some margin accounts that have enough equity in them a day ago are under water now.  So Shanghai and Shenzhen will likely open tonight to more selling.

–to be clear, I don’t know exactly how Chinese margin works.  And, because I have no intention of buying A shares, I have no desire to find out.  A logical step for authorities to stop forced selling would be to loosen margin collateral requirements.  It may be, however, that the government has decided that the best course is to wring speculation out of the market as quickly as possible.  In other words, despite its rhetoric, it’s content to see the selling play itself out fully.

–margin players tend to be their own worst enemies.  Taking both their margin and cash accounts into consideration, they tend to have a mishmash of high quality stocks and speculative junk.  Their margin accounts tend to be heavily weighted toward trash.  The junk is what’s most vulnerable to price declines, since it has little, if any, intrinsic merit.  The logical response to a margin call is to sell the trash and keep the quality names.  Margin players, in my experience, invariably do the opposite.  They sell their winners and keep their losers, exposing themselves to continuing margin calls and prolonging the overall market agony beyond what it should be.

–I’m still guessing that the current selling will exhaust itself within two weeks.

the Chinese stock market now

July 7, 2015 By in China, Hong Kong, margin trading, Stock Connect Tags: , , , , 1 Comment

declining stocks

Until about a month ago, Chinese stocks were soaring.  Over the prior year the main indices in both Shanghai and Shenzhen were up by about 150%.

Since then, however, both markets have been in a continuous tailspin, dropping a quarter of their value.

Beijing has just announced emergency stock market stabilization measures aimed at halting the fall, on the idea that swooning stocks will hurt capital formation (duh!) and clip a percentage point or more from economic growth–at a time when China doesn’t have that many points to spare.

What’s going on?

As part of its plan to gradually modernize its equity markets and ultimately open them to the outside world, China introduced margin trading (as well as stock index futures and short-selling) domestically in 2010.  China is now going through what all emerging markets eventually do–its first full-blown margin trading crisis.

margin trading

There are lots of ins and outs to margin trading, but it’s basically using the stocks you own as collateral for loans to buy more shares.  It can be very seductive when stocks are going up.  And it’s immensely profitable for brokers.  So it’s not surprising that margin loans are easily available to lots of customers.  Also, in many emerging markets, China included, it’s relatively easy to circumvent restrictions on margin lending by arranging bank loans collateralized by stocks that may not technically be margin borrowing, but effectively are the same thing.

The key aspect of margin trading is that the value of the securities in the account must exceed the margin loan total by a certain safety amount.  If prices fall to the extent that the safety amount shrinks, or is wiped out, the broker has the right to sell enough securities from the account to restore it.  He may call the client and give him the opportunity to add more money to the account   …or he may just sell.

However, this selling itself depresses prices further–eroding the value of the remaining securities in the account as well as any safety amount that may be built up.

Also, margin traders around the world tend to be both the ultimate dumb money and the ultimate herd animals.  They all but the same speculative stocks and they (almost) all leverage themselves to the eyeballs. Even if customer A is initially in fine shape, the selling in the accounts of customers B,C and D will pressure the margin balance of A as well as their own.

The first selling, then, tends to create an accelerating cascade of more selling that’s extremely hard to stop.

This is what China is experiencing now.  This is also why the government has stepped in with a massive market support operation to try to staunch the flow.

effect on the rest of the world?   …especially you and me

The Stock Connect linking mechanism between Shanghai and Hong Kong–aimed a diverting funds away from soaring mainland stocks–is now exporting the mainland weakness in much milder form to the Hang Seng.

Beijing has a ton of money and its stock markets are, realistically speaking, still not very open to the outside world.  As the current anticorruption campaign shows, the CCP has lots of ways to punish people who do stuff it doesn’t want.  So I imagine that the government will stop the downward stock market momentum.  The big questions are:

–how long will it take, and

–how large an unwanted portfolio of stocks (which will act as an overhang on the market) will Beijing have to purchase in order to achieve the stabilization it wants.

My answers are:

–I don’t know, but probably not more than a couple of weeks, and

–I don’t care, because I think the way to play a potential rebound from oversold levels is through the Hong Kong stocks now being sold by mainlanders.

MSCI and China’s A shares

June 18, 2015 By in Asian economic development, China, emerging markets, Hong Kong, Purchasing power parity (PPP), securities markets, short selling, Stock Connect, stock market Tags: , , , , , , , Leave a comment

A few days ago, MSCI, the premiere authority on the structuring of stock market indices around the world, declared that it had been carefully considering adding Chinese A shares to its Emerging Market indices–and concluded that it would not yet do so.

What is this all about?

MSCI

MSCI (Morgan Stanley Capital International) creates indices that investment management companies use to construct their products–both index and actively managed– and to benchmark their performance.

Having a certain stock, or a set of stocks, in an index is a big deal.   For passive investors, it means that they must hold either the stocks themselves or an appropriate derivative.  Either way, client money flows into the issues.

For active investors, they’re forced to at least research the names and keep them on their radar.  If they don’t hold a certain stock or group, they’re at least tacitly betting that the names in question will underperform.

 

If we measure economic size using Purchasing Power Parity, China is the largest in the world.  It seems odd that the country not be fully represented in at least Emerging Markets indices.

 

China

Beijing, in the final analysis, would like to have international investors studying A shares deeply and buying and selling them freely.

How so?

In many ways, the story of the growth of the Chinese economy over the past three decades has been one of slow replacement of the central planning attitude of large, stodgy state-owned enterprises with the dynamism of more market based rivals.  The heavy lifting has been done by constant political struggle against powerful entrenched, backward-facing, political interests that even today control some state-owned enterprises.  It would be nice for a change to have the market do some of the work–by bidding up the stocks of firms that increase profits and punishing those that simply waste national resources.

 

In addition, Beijing now seems to believe that freer flow of investment capital in and out of China can act as a safety valve to counteract the extreme boom/bust tendency that the country’s domestic stock markets have exhibited in the past.

 

the burning issue?

Foreign access to the A share market is still too limited.

Fir some years, China has had a cumbersome apparatus that allows large foreign institutions to deposit specified (large) sums of money inside China and use the funds to buy and sell stocks.  But becoming a so-called qualified foreign institutional investor and operating within government-set constraints is a pain in the neck.  It’s never been a popular route.

Recently, Beijing has begun to allow investment money to flow more freely between Hong Kong and Shanghai.  A HK-Shenzen link is apparently also in the offing.

In MSCI’s view, this isn’t enough free flow yet.  I think that’s the right conclusion.  Nevertheless, weaving A shares into MSCI indices is only a question of time.

my thoughts

As professional securities analysts from the US and elsewhere turn their minds to A shares, there stand to be both big winning stocks and equally large losers.  The big stumbling block will be getting reliable information to use in sorting the market out.

cooling the Chinese stock market fever

April 17, 2015 By in "naked" short selling, Banks, China, commodies speculation--stabilizing or destabilizing?, Investment firms, Margin, securities markets, short selling, stock market Tags: , , , , , , , , 1 Comment

In the 1990s, Alan Greenspan, the head of the Fed back then, famously warned against “irrational exuberance” in the US stock market, but did nothing to stop it   …this even though he had the ability to cool the market down by tightening the rules on margin lending.  This is the stock market  analogue to raising or lowering the Fed Funds rate to influence the price of credit, but has never been used seriously in the US during my working life.

The  Bank of Japan has no such compunctions.  It has been very willing to chasten/encourage speculatively minded retail investors by tightening/loosening the criteria for borrowing money to buy stocks.

 

We have no real history to generalize from in the case of China.  But moves in recent weeks by the Chinese securities markets regulator seem to indicate that Beijing will fall into the stomp-on-the-brakes camp.

Specifically,

–at the end of last month, the regulator allowed (ordered?) domestic mutual funds to invest in shares in Hong Kong, where mainland-listed firms’ shares are trading at hefty discounts to their prices in Shanghai

–highly leveraged “umbrella trusts” cooked up by Chinese banks to circumvent margin eligibility requirements have been banned,

–a new futures product, based on small and mid-cap stocks, has been created, offering speculators the opportunity to short this highly heated sector for the first time, and

–effective today, institutional investors in China are being allowed to lend out their holdings–providing short-sellers with the wherewithal to ply their trade (although legal, short-selling hasn’t been a big feature of domestic Chinese markets until now, because there wasn’t any easy way to obtain share to sell short).

What does all this mean?

The simplest conclusion is that Beijing wants to pop what it sees as a speculative stock market bubble on the mainland.  It is possible, however, that more monetary stimulus–to prop up rickety state-owned enterprises or loony regional government-sponsored real estate projects–is in the pipeline and Beijing simply wants to dampen the potential future effects on stocks.

I have no idea which view is correct.

It’s clear, however, that Hong Kong is going to be a port in any storm, and that it is going to be increasingly used as a safety valve to absorb upward market pressure from the mainland.  So relative gains vs. Shanghai seem assured.  Whether that means absolute gains remains to be seen, although I personally have no inclination to trim my HK holdings.