Much Volatility Still Present in The Chinese Market

November 27, 2015
Just when it looked like the Chinese market was becoming relatively stable, overnight China’s benchmark Shanghai composite fell over 199 points or about 5.5%, while the main index in Shenzhen and the Chinext each lost 6.1%, prompting other Asian markets to close in the red.  This brings back bad memories of the massive selloff from mid-June to late August, when Chinese markets saw nearly $5 trillion of investor value wiped off the books.  This single day drop was enough to nearly wipe out investor gains for the entire month of November; it is the largest single day drop in 3 months.
Late Thursday, several major brokerage firms announced they were under investigation by the China Securities Regulatory Commission (SCRC).  Citic Securities, Guosen Securities, Founder Securities, China Merchants, and China Haitong Securities admitted to being scrutinized for the possible breaking of market rules regarding leveraged trading.  Shares in both Citic and Guosen fell by 10%, the maximum allowed in one trading day; and shares in China Haitong had to be halted.
Reuters news reported that Chinese regulators are urging brokerages to stop financing investors’ stock purchases through swaps in an attempt to curb leveraged trading.  Regulators have been trying to reign in leveraged and margin trading since the Chinese indices’ massive plunge during the summer.  Haitong and another brokerage, Guotai Junan Securities, are also both being probed for insider trading and short selling.  Guatai’s CEO, Yim Fung, has been missing since November 18th, and the brokerage does not seem to know his whereabouts.  Even the assistant chairman of the SCRC Zhang Yujun has been removed from office for severe violations of discipline, including bribery, fraud, and “under-the-table” deals.
On Wednesday, the Securities Association of China said that Citic had overstated the value of some of its derivatives by about 1.1 trillion yuan ($172 billion USD).  The overstatements were contained in reports on trades carried out during the summer’s stock market dramatic selloff.  The company says the overstatement was the result of a “reporting error.”
Chinese investors and traders are already skittish ahead of a new set of IPOs set to launch next week, after a 4-month freeze.  The selloff is in part due to traders hoping to cash in on the typical 40+% rise in new issues on the first day of trading.  This heightens market volatility as investors sell holdings to raise cash for new issues, draining funds in the market for the short term.
Investor confidence had already been dampened by government figures showing industrial profits fell by 4.6% in October versus the same period last year.  This is the 5th straight month of declining profits, fueling concerns of a slowdown in the world’s second largest economy.  Chinese consumers simply are not buying, creating surplus inventory, and lower corporate profits.
Tuesday, the government will release the official PMI factory numbers, which is likely to show a shrinking in China’s manufacturing sector for the fourth straight month in November.  With the IPO launches and the PMI numbers next week, we may yet see more volatility in the Chinese market.