China’s financial watchdog is increasingly worried about speculative leverage on the soaring Shanghai and Shenzhen equity markets, fearing a repeat of the boom-bust debacle in 2015 when the crash almost spun out of control.
The China Securities Regulatory Commission has blacklisted 258 brokerage houses accused of offering illegal margin accounts at 10 times leverage. It told investors to “raise their risk awareness” before the buying frenzy reaches dangerous levels.
The state media followed with sober reminders of the “tragic lesson” five years ago, when the market spiked and then plunged 40pc. That episode shook confidence in the authorities and combined into a currency crisis that proved hard to contain. In the end the People’s Bank had to burn through $1 trillion to defend the exchange rate and counter capital flight.
Official data for June shows that households opened 85,000 new margin trading accounts, the method used by small retailer players to play the casino with borrowed money. The Shanghai Composite index has jumped 20pc since late June, with parabolic moves earlier this week.
This high-risk form of finance famously fueled the final leg of the Wall Street bubble in 1929. In China it has jumped to a five-year high of $260bn, but still well short of the peak five years ago. Bocom International estimates that some 12pc of all equity trades are now taking place on margin.
The authorities seem to be pulling in different directions. The messaging has been confused. On Monday the state-owned China Securities Journal published a front-page editorial extolling a “healthy bull market” and exhorting investors to fill their boots, which they duly did. The regulators are clearly trying to rein back in animal spirits.
“The leadership wants to see prices roll but the regulators know they will take the blame if it all goes wrong. In 2015 they were fired,” said Mark Williams from Capital Economics. “Fundamentals don’t look too stretched yet, but if prices keep rising like this for another few weeks it is going to turn into a bubble.”
The purported justification for the equity boom this time is the “pandemic dividend” from China’s quick suppression of the virus. In 2015 it was Xi Jinping’s supposed “reform dividend”, a glaring irony in retrospect since China has, if anything, reverted to its variant of Leninist state-capitalism.
Goldman Sachs told clients that the rally still has far to run, predicting a further rise of 15pc in the CSI 300 before it all comes tumbling down again next year.
“We maintain our strategic overweight position on China equities,” said Frank Benzirma from Societe Generale. “It is too early to call the peak.” The French bank said profits are holding up and the fiscal cavalry is arriving, almost guaranteeing a full V-shaped recovery.
Mr Benzirma said outstanding margin purchases reached 10pc of total market capitalisation in 2015. This time they have yet to pierce 5pc. The trailing 12-month price-to-earnings ratio on the CSI 300 is 15.9, compared to more than 20 times in the last bubble.
The Chinese equity markets dance to their own tune, often decoupled from anything going on in the real economy. They are highly sensitive to buy or sell signals from the political leadership.
Just 3pc of Chinese people own shares, and among those who do it averages just 1pc of their total assets. The wealth effect of stock moves on economic growth is therefore much lower than in the US or Europe.
Yet it is clear that the stars now are now aligned for genuine recovery later this year in China, though much depends on the trade "blowback" from second waves of Covid in the rest of the world.
The augmented fiscal deficit is heading for 15pc of GDP and a blast of stimulus is feeding into the economy. The authorities have again thrown caution to the winds, reverting to their old reflex of metal bashing, coal burning and top-down infrastructure investment.
Mr Williams said the spending is equal in scale to the gigantic package after the Lehman crisis, although Beijing is less promiscuous with credit this time. Whether the money is being well spent is another matter. “An awful lot of concrete is going to be poured that isn’t really needed,” he said.