China’s shares started the year with a large drop, which triggered special measures designed to reduce volatility and resulted in a suspension of trading on January 4.
The CSI 300 index had its worst trading day in nine years, dropping 7%, while the Shanghai Composite Index and the Shenzhen Index also suffered falls.
This performance triggered the use of the so-called ‘circuit breakers’ on the first day of their introduction. These are designed to suspend trading for 30 minutes when markets rise or fall by 5% and stop trading for the day if the market moves by 7%.
Against this backdrop, Citywire Selector asked China equity specialists why the market dropped and if it will continue to suffer from volatility that plagued it in 2015.
Citywire + rated Jian Shi Cortesi, who runs the Julius Baer EF China Evolution fund, believes the mentality of some investors contributed to the fall in the market and was exacerbated by the circuit breakers.
The purpose of these circuit breakers is to reduce volatility and to reduce panic, but I have been concerned by this rule since it was proposed, since it could have the opposite effect.
The Chinese A-share market is a retail investor driven market. More than 90% of the trading is done by retail investors who have very high turnover. They trade daily and don't trade on fundamentals; they trade on rumours, news and sentiment.
Imagine when the market is down 4% a lot of the retail investors will think they need to sell before the market suspends trading. Once trading is suspended no one can sell anymore. Then you actually generate more selling pressure.
I am quite concerned about this circuit breaker mechanism and I think it may have the opposite effect of its original purpose of reducing volatility. After some time people will get used to the circuit breaker rule. I think it is pushing market participants to move in one direction.
The real problem is the market participants. In most of the developed markets most of the trading is done by institutions, like fund managers, insurance companies, pension funds, they tend to be more rational.
In China, 90% of the trading is done by individual investors but they treat the stock market like a casino. That dynamic will change as the pension system starts to be developed and people put more savings into pension funds.
Citywire A-rated Vanessa Donegan, head of Asia equities at Columbia Threadneedle Investments, said that renminbi weakness and political concerns in the Middle East were two of the causes for the fall in the market. She thinks this round of volatility can be traced back to last year.
The technical position for China’s A-share market is looking ugly as the temporary ban of major shareholders from offloading shares bought during the support programme of last July will expire later this week.
Furthermore, the resumption of initial public offerings under a new system for registration and a long list of potential private placements means that there is a hefty amount of stock to be digested in the coming months.
Retail investors, who account for over 80% of trading on the mainland stock markets, may have been looking for an excuse to take profits on their positions after the CSI 300 index of mainland listed shares rallied over 30% from its August lows, while the Chinext index had delivered a spectacular gain of 85% in 2015.
However, Chinese shares listed in Hong Kong, where there is no circuit breaker in operation, extended losses after the halt on mainland exchanges. Investors may have attempted to use Hong Kong to hedge their positions. If this trend persists it may throw up opportunities for bargain hunting as Chinese shares listed in Hong Kong trade at significant discounts to their A-share counterparts.
Head of Greater China equities at BNP Paribas Investment Partners, Citywire AA-rated Caroline Yu Maurer, thinks a recovery is possible in 2016 and the country will grow in the service sector.
Last year was an extremely volatile one for Chinese equities, with 2016 beginning in a similar vein, and it is therefore entirely understandable that many international investors have remained sidelined. Furthermore, the conventional macro data prints in the second half of the year have yet to provide solid proof that the economy has turned the corner. Nonetheless, we remain cautiously optimistic that China will experience a cyclical recovery in 2016.
Faced with moderating external demand in recent years, China has been addressing the challenging task of rebalancing the economy by pushing forward reforms to upgrade China’s value chain to promote more sustainable growth drivers - while at the same time ensuring that employment and social stability is maintained.
For 2016, the government is signalling that it remains committed to pushing ahead with the necessary supply-side structural reforms to deal with some of the heavy overcapacity in industries such as steel and cement.
We believe this task is necessary over the medium term to facilitate more effective allocation of capital. In the near-term, we expect a cyclical recovery if the property sector continues its trend of improvement, aided by supportive monetary and fiscal policies to counter the slowing manufacturing segment.
Andy Rothman, who is an investment strategist at Matthews Asia specialising in the Chinese market, said investors need to take an active approach and that there are opportunities for smart investors.
Everybody is invested in China even if they don't own any Chinese shares because China accounts for one third of global growth that is a bigger share of global growth that the US, Europe and Japan combined. So we are all China investors.
There is extremely little correlation between the Chinese A-share market and what happens in the Chinese economy. There was no Chinese economic news, no corporate news that would justify or explain why the Shanghai composite index went from up 9% year over year at the close last week. This made it one of the best performing markets in the world to where it closed down 2% year-over-year. This is just an illustration of how incredibly volatile that market is.
Will there be an end to volatility in the Chinese market? Not any time in the near future. You have to keep in mind that the Chinese stock market has only been around for about 25 years so it is very immature and it is going to take many years for this to become a more stable, broadly held and broadly representative market. During that time we need to get used to volatility, what it says about China and understand what drives it.