China Plunges Most Since 2007, Points Away From Bear Market; Greek Drama Continues

Following yesterday's furious market drop in Chinese stocks, just before the overnight open, Morgan Stanley came out with a much distributed report urging investors "Not to buy this dip", and so they didn't. As a result, the Shanghai Composite imploded, at one point trading down 8% while the Chinext and Shenzhen markets crashed even more. This was the single biggest Shanghai Composite one-day drop since 2007, and with a close at 4192.87 the SHCOMP is now on the verge of a bear market, down 19% from its June 12 highs. China's second largest market, Shenzhen, is now officially in a bear market.

We wonder if the media will blast that Chinese stocks have lost $2 trillion in 2 weeks with the same euphoria as they explained how Chinese stocks crossed $10 trillion in market cap precisely two weeks ago. 

What caused the plunge? Many factors were involved, and here is a brief summary from RanSquawk:

  • In recent weeks, the Shanghai Comp has traded in a volatile fashion and has on occasions seen intraday declines of around 4% before staging a late rally to close positive.
  • This volatility also follows the stellar rally seen in Chinese stocks with the Shanghai Comp still up by around 34% YTD, amid a surge of speculation by Chinese household investors which have been turning to stocks for investment purposes following a slump in the property sector, 
  • Today's declines are also in the wake of a reduction in margin trading, as the recent measures taken by brokerages to cool down margin trading amid overheating and bubble fears, has seen traders offload shares purchased through margin financing for a 4th consecutive day.
  • Also worth noting, yesterday's decision by the PBoC to conduct a 7-day reverse repo for first time in 2 months led to analysts reducing calls of a RRR cut, further dampening sentiment.
  • In addition, the latest round of IPOs including Guotai Junan which is China’s largest in 5 years, has also competed for funds in the market with the stock rising by 44% on its debut.  
  • Several financial institutions have also warned of a ‘bubble’ from China with BofA recently commenting that Chinese stocks are in the largest bubble since 2000 and will fall by 20%-30% when the bubble bursts, while Credit Suisse stated that China's bubble could begin to burst within the forthcoming 6-months. In addition, Morgan Stanley earlier today warned investors not to buy the dip.

According to the WSJ, the drop in margin debt may have been the catalyst, and reports that "combined margin loans outstanding in Shanghai and Shenzhen experienced four consecutive days of shrinkage this week, the first time that has happened since April 2014, before the stock lending boom took off. In total, margin loans have increased more than fivefold in a year to 2.2 trillion yuan ($350 billion)."

As the WSJ notes "It is possible tightening margin rules and jittery brokerage loan desks are the cause of the selloff. Securities rules used to require that margin loans be closed out every six months and not be rolled over. But that requirement was unwound earlier this month."

Yes, but margin debt is usually a coincident if not lagging indicator to the market as such we doubt there is much information to be gleaned here aside from concluding that the mania phase in China has finally popped and at this point it is merely damage control.

Bloomberg confirmed as much, reporting that as panicked investors sought the reassurance of the communist party through its outlet, the Xinhua website, only not to find much solace or clarity: "Yao Lina, an accountant in Shanghai, is looking for clues in the state media before deciding whether to get back into stocks. She sold everything last week. “The tone from the state media is particularly helpful to retail investors like me, as I have a job to do and am pretty busy,” said Yao, 35. “China’s stock market is really different from other countries. The government surely has some measures to control the movement.”

Actually by that definition it's not different at all. So what did Chinese investors find?

The recent quiet has prompted speculation that Chinese authorities are willing to tolerate greater market volatility. On Tuesday, for instance, the Shanghai Composite Index fell as much as 4.8 percent before more than wiping out its losses in the biggest same-day recovery in eight years.


Not long ago, Xinhua and others leapt into action when the market swooned. In January and again in May, Xinhua responded to steep declines within hours. Its reassuring takeaway: the record rally was alive and well. In both instances, the Shanghai index rebounded more than 7 percent within a week.


Given that history, many looked to the state media after the index plunged 6.4 percent last Friday. So far, Xinhua has provided no take on what that decline might mean. The Shanghai Composite sank another 7.4 percent on Friday to the lowest level in seven weeks.

So first Beijing blows its biggest stock bubble since 2007 and now it allows it to pop? Surely this will have a tremendous impact on China's Q2 economy.

In any event, for China Friday is now over, as are the most disastrous two weeks in trading history.

And now all eyes shift to Brussels and the ongoing Greek drama where there is relatively little to report as there are no formal talks ahead of tomorrow's latest "deadline" to get a Greek deal done ahead of the Monday market open as Merkel demands.

Stocks traded lower in Europe this morning, with the weakness observed across all traded sectors. Much of the weakness stemmed from the fact that yet again officials involved in Greek debt talks failed to agree to end the saga. So much so that an EU official stated that there will not be a summit today for Euro leaders, with tomorrow’s Eurogroup meeting seen as a day when a deal has to be made between Greece and their creditors.

In spite of this, the most notable activity came from a mega merger approach from Potash for the German listed K+S, which saw its shares rise over 30%. At the same time, UK listed Tesco shares rose 3% while also lifting other retail names, following its trading update.

While both EUR/USD and GBP/USD have gradually come off lows and into minor positive territory, the upside momentum has since subsided as market participants await further developments regarding the Greek debt saga. At the same time, commodity linked currencies traded lower, as concerns over growth prospects in China is expected to dampened demand for raw materials.

WTI and Brent crude futures traded lower, driven in part by the ongoing concerns of an economic slowdown, as the PBOC remains reluctant to cut RRR to stimulate recovery.

In summary: European shares remain lower, though off intraday lows, with the basic resources and oil & gas sectors underperforming and retail, real estate the only sectors to gain. Chinese stocks fall, capping biggest 2-week loss in more than 18 years. ECB said to leave emergency liquidity for Greek banks unchanged. Euro-area leaders convening in Brussels for a second day of talks today for a regularly scheduled summit where Greek talks aren’t officially on the agenda. Merkel says European leaders agreed that everything must be done to find a solution on Saturday. Japanese May core CPI rises 0.1% vs 0% est. The Swiss and U.K. markets are the worst-performing larger bourses, the Spanish the best. The euro is little changed against the dollar. Portuguese 10yr bond yields rise; Italian yields increase. Commodities little changed, with nickel, natural gas underperforming and wheat outperforming. U.S. Michigan confidence due later.

Market Wrap

  • S&P 500 futures down 0.1% to 2092.7
  • Stoxx 600 down 0.6% to 394
  • US 10Yr yield down 1bps to 2.4%
  • German 10Yr yield down 1bps to 0.85%
  • MSCI Asia Pacific down 0.8% to 148.1
  • Gold spot up 0.1% to $1174.4/oz
  • Eurostoxx 50 -0.6%, FTSE 100 -0.9%, CAC 40 -0.4%, DAX -0.5%, IBEX -0%, FTSEMIB -0.5%, SMI -1%
  • Asian stocks fall with the Kospi outperforming and the Shanghai Composite underperforming, MSCI Asia Pacific down 0.8% to 148.1
  • Nikkei 225 down 0.3%, Hang Seng down 1.8%, Kospi up 0.2%, Shanghai Composite down 7.4%, ASX down 1.5%, Sensex  down 0.3%
  • Euro down 0.06% to $1.1198
  • Dollar Index up 0.03% to 95.21
  • Italian 10Yr yield up 5bps to 2.14%
  • Spanish 10Yr yield up 3bps to 2.09%
  • French 10Yr yield down 0bps to 1.23%
  • S&P GSCI Index down 0.1% to 433.9
  • Brent Futures down 0.2% to $63.1/bbl, WTI Futures down 0.4% to $59.5/bbl
  • LME 3m Copper down 0.2% to $5759/MT
  • LME 3m Nickel down 1.4% to $12520/MT
  • Wheat futures up 1.4% to 545.8 USd/bu

Bulletin headline summary from RanSquawk and Bloomberg:

  • An EU official stated that there will not be a summit today for Euro leaders, with tomorrow’s Eurogroup meeting seen as a day when a deal has to be made between Greece and their creditors.
  • German listed K+S shares surged over 30% following reports of a mega takeover approach from Potash.
  • Going forward, the focus will be on any updates relating to the never-ending Greek debt talks, U. Michigan Sentiment release and comments by BoE’s Carney.
  • Treasury yields mostly steady in overnight trading as China stocks plunge and European finance ministers prepare for a weekend meeting concerning Greece.
  • As Chinese shares turn from the world’s best performers into the biggest losers, concern is spreading among individual investors who account for more than 80 percent of trading on mainland exchanges
  • German Chancellor Merkel and her fellow EU leaders told their finance ministers to unblock Greece talks once and for all as positions hardened around conditions the country must meet to secure aid
  • Greek PM Tsipras met with German Chancellor Merkel and French President Hollande today ahead of a weekend that may decide the country’s fate in the euro
  • If Greece fails to pay the $1.7 billion it owes the International Monetary Fund on Tuesday, it might be worse for the lender than for Greece
  • The ECB left the level of emergency cash available to Greek     banks unchanged for a third day today, people familiar with the decision said
  • Ukraine said it was prepared to halt coupon payments as it blamed the deadlock in a $19 billion restructuring on a creditor group led by Franklin Templeton
  • Sovereign 10Y bond yields mixed, with Greece falling 6bps; Portugal, Italy and Spain yields higher. Asian, Europeanstocks drop, U.S. equity-index futures fall. Crude oil and copper drop, gold higher

US Event Calendar

  • 10:00am: U. of Mich. Sentiment, June final, est. 94.6 (prior 94.6)
  • U. of Mich. Current Conditions, June (prior 106.8)
  • U. of Mich. Expectations, June (prior 86.8)
  • U. of Mich. 1 Yr Inflation, June (prior 2.7%)
  • U. of Mich. 5-10 Yr Inflation, June (prior 2.7%)
  • 10:45am: Bank of England’s Carney speaks in London
  • 12:45pm: Fed’s George speaks in Kansas City

DB's Jim Reid completes the overnight recap

I can't help thinking that the last 5-6 months of the EMR have included lots of pointless stuff on Greece which will be superseded by events one way or the other over the weekend. Never have I known a story with so much noise and so little action. However the clock has ticked ever closer to 11:59:59 even though midnight has been a bit of a moving target of late. It’s possible that no deal before the month-end IMF payments are due on Tuesday could pass without a major incident should the ECB see that sufficient progress has been made to warrant a raise in the T-Bill ceiling to ultimately accommodate the IMF payment. However, the probability of this is low (given it would also require some sort of progress on the Greek domestic political front) and ultimately the potential for the ELA cap for Greek bank funding to be turned off next week will likely depend on how events unfold over the next couple days.

As it stands another Eurogroup meeting has been scheduled for Saturday with technical teams due to resume negotiations in the mean time in the hope that an agreement is made before the meeting. Yesterday’s stalemate came after Greece and its Creditors again failed to bridge the remaining gaps that have plagued an agreement being reached, with signs of agitation in the European camp. German Chancellor Merkel warned that ‘we don’t have the necessary progress’ and that ‘one even has the impression that we’ve regressed a bit’. Merkel also suggested that an agreement needs to be reached before markets reopen again on Monday. Overnight (at around 3am CET) and speaking after the conclusion of the first day of the EU Summit, Merkel has reiterated that Saturday’s Eurogroup will be decisive and that a lot of technical details from Greece need to be resolved. When questioned on whether or not an agreement will be reached, the German Chancellor replied that ‘whether they can do that, I can’t say. But the political will of all the leaders present with respect to Greece was clear’. French President Hollande, also speaking shortly after, said that ‘we must do everything to reach a global and durable accord’ and that ‘Greece must make proposals that will allow institutions to enter a conclusive phase’.

Ultimately the ball appears to lie once again with Greek PM Tsipras in the hope that he backs down further to the Creditors demands. In the meantime, Tsipras remained defiant yesterday, saying that ‘I think that European history is full of disagreements, negotiations and at the end, compromises’ while also stating that ‘I am confident that we will reach a compromise that will help the eurozone and Greece to overcome the crisis’. German Bundesbank President Weidman, meanwhile, appeared to criticize the role of the ECB’s liquidity facility for Greek banks after saying that ‘it should be clear to all the parties to the current negotiations that the Eurosystem must not provide bridge financing to Greece even in anticipation of later disbursements’.

The DB house view (and ours) is that a last minute deal continues to be the most likely outcome. However if there was ever a situation that could bring an accident then no-one would really be shocked if it was this one. If there was an accident expect markets to have a period of notable instability but one would think that central banks would flood the system with even more liquidity if things escalated. Given this and the reduced contagion risks now vs. 2011/2012, the negativity should last days or weeks rather than months. It would likely be a big blow to the longer-term sustainability of the Euro given that it sets a precedent but that's a medium-term story. If a deal is struck we should see a big relief rally in risk as it seems investors have stayed on the sideline of late. Capital market activity would likely pick up after a relatively quiet couple of months in Europe due to first higher yields and more recently Greece. So a lot at stake over the next couple of days.

There continues to be a vast amount of noisy headlines appearing daily on the saga which is causing short term reactions in markets. Yesterday this was clearly evident in equity markets in Europe where the Stoxx 600 eventually closed down -0.23%, although bounced around over the course of the session. The CAC (-0.07%) and IBEX (-0.12%) also closed lower while the DAX (+0.02%) finished more or less unchanged. Despite the lack of progress, Greek equities muddled the picture by closing up +0.10% although the index passed between gains and losses 15 times during the day. There was similar intraday volatility in the European bond market where we saw 10y Bunds close 1.8bps higher at 0.859% having traded in a 7bps range. Peripheral yields actually fell, led by Portugal (-5.9bps) while Spain and Italy finished -4.6bps and -3.6bps respectively. Greek 10y yields ended the day 14.4bps higher. In terms of the data flow in Europe German consumer confidence data did little to move the dial (10.1 vs. 10.2 expected).

It was a softer day across the pond yesterday too for US equities as the S&P 500 (-0.30%) and Dow (-0.42%) were dragged down by a fall for energy stocks in particular, offsetting a rise for health care names after they were supported by the news that the Supreme Court had upheld a key part of President Obama’s health-care law. US equities have traded in a reasonably tight range for some time now and interestingly as it stands, the S&P 500 is on track for a ninth consecutive week without a move of more than +/-1% which is the longest such streak since 1993. It was slightly softer day for the Dollar yesterday, paring earlier gains into the close as the Dollar index finished down 0.08%. Yesterday’s modestly better than expected data did help support a rise in Treasury yields however as the benchmark 10y ended 4.2bps higher at 2.410%.

Just on the data, personal spending for the month of May rose above expectations to +0.9% mom (vs. +0.7% expected) while there was also an upward revision to April’s print (+0.1% mom from 0.0%). Personal income (+0.5% mom) was in line with consensus, as was the PCE deflator for last month at +0.3% mom. The annualized rate remained at +0.2% yoy following an upward revision to April’s print by one-tenth of a percent. The core PCE was also as expected at +0.1% mom. Jobless claims continue to remain relatively solid following a 3k rise to 271k (vs. 273k) which marks the 16th consecutive week now of a sub-300k reading. The flash June services PMI reading was less encouraging however, after falling 1.4pts to 54.8 (vs. 56.5) which is the lowest level since January. Finally there was also some more weakness in the Kansas City Fed manufacturing activity index which, despite rising 4pts, still remains at lowly levels at -9.

Onto markets in Asia now, equity markets have extended declines in the morning session and are led once again by China where the Shanghai Comp and Shenzhen are -4.06% and -6.19% respectively as we type. Elsewhere, the Hang Seng (-1.49%), ASX (-1.51%) and Nikkei (-0.10%) have also dropped. The latest move lower in China also comes after 30-day volatility on the Shanghai Comp index struck a 6-year high. Looking at the bond market, 10y Treasury yields are 1.1bps lower as we go to print, while credit markets across the region are off to a quiet start with indices broadly unchanged. Data this morning came out of Japan where we saw CPI for the month of May print at +0.5% yoy, slightly ahead of expectations (of +0.4%) but down a tenth from last month. Core CPI rose +0.1% yoy (vs. 0.0% expected) and core-core, or ex food & energy, rose +0.4% yoy as expected.

Looking at the day ahead now, Greece headlines will likely dominate markets for the most part today while data wise in Europe this morning the only releases of note are the German import price index, French consumer confidence and Euro area money and credit aggregates data. This afternoon in the US we receive the final June University of Michigan consumer sentiment reading while the Fed’s George is due to speak.

Batten down the hatches for an interesting weekend.