China's market has further room to fall

Asian markets remain under pressure on Friday, despite the highs of the US markets and a brisk strengthening of European indices. Hong Kong’s Hang Seng lost 0.5%, and the China A50 blue-chip index was down 0.2%. At the same time, Japan’s Nikkei is down 0.6%, and Korea’s Kospi is down 1.4%.

However, this slight decline in China today should not be misleading. Chinese indices sharply retraced their decline earlier in the week, failing to develop a rebound after drop since May’s peak. The fear of continuing regulatory pressure in China gives investors little reason to buy cheaper shares.

Earlier, the buying impulse in Chinese equities was on assurances from the authorities that there is no systemic crisis. However, the officials did not go further: there was no meaningful policy reversal, and we saw new signs of pressure on private companies - now from the semiconductor sector. Fines, antitrust investigations, and restrictions remain a relevant threat hanging over China and are dragging down related markets overseas.

We have previously seen China put severe negative pressure on its markets. Then, in 2015, a booming influx of retail investors into local markets created a strong growth momentum. It was largely margin buying, increasing risk in the financial system, which prompted the government to tighten regulations, including foreign investors who suffered from a managed depreciation of the renminbi.

At some time, the sell-off in local markets threatened financial stability, prompting regulators to soften positions. In the nine months from May 2015 to February 2016, the China A50 lost more than 43%, and the Hang Seng was down 37%.

The current pressure on the indices has taken about half as much away, returning indices to late 2020 levels, although we have seen falls of over 90% in individual stocks.

The technical picture also suggests considerable room for further declines in the coming months. The long-term charts clearly show how political interventions (regulatory pressure in 2015 and trade wars in 2018) turn the indices towards the lower end of a broad trading range. And at its lower end, politicians are already making a truly bold effort to stabilize the market.

Unfortunately, we are not there yet. The lower boundary of this channel for the Hang Seng passes through 22000 by the end of the year versus the current 26200. In China A50, the global support line passes through 13300 against the current 15700. In both cases, the potential for a further drop of about 15% remains.

Statistics from China also continue to point to a slowdown. Loan volume has maintained a downward trend since the start of the year, and the latest figures have fallen short of expectations. The M2 money supply growth rate has fallen to its lowest in 2018-2019, barely exceeding 8% y/y.

And this potential is something investors should keep in mind when trying to assess whether Chinese equities have fallen sufficiently in price to become attractive for a discounted purchase.

There has been speculation in the press that the People’s Bank of China is set to ease credit conditions to maintain growth momentum. However, investors in the markets should remember that it will take months for the easing from the central bank to influence the economy. In addition, as we have seen so far, it is not sufficient to get the sustained interest of buyers back on track.

Buying Chinese indices right now seems premature until we see an apparent reversal in the policy of Politburo.