Even after this somewhat catastrophic drop, BofAML warns the Chinese market looks expensive. Deleveraging is likely far from over, they add, concluding that the market is a "falling knife" and only direct buying by the government will mark the bottom.
Bottom likely when govt becomes buyer of last resort
After reaching a peak of 5,166 on Jun 12, SHCOMP declined sharply by almost 30% to 3,687 within three weeks. The ferociousness of the sell-off even took us by surprise – although we have a 3,600 target for the index, we thought it would take another six months to get there. Given the momentum, the market bottom is highly unpredictable. As a result, we suggest investors stay on the sidelines for the time being. A few points worth highlighting:
The market is now a “falling knife”: even after all the government directed marketsupporting measures since last Saturday, including comb rate/RRR cuts, CSRC’s loosening of margin lending control & its cracking down on shorting activities, and organized commentaries from high profile local fund managers, the market still dropped sharply on four of the last five trading days and fell decisively through the psychologically important 4,000 level for SHCOMP. The market has clearly lost its nerve and many investors appear to be rushing to exit.
Drastic times calls for drastic measures: the government still has a few policies up its sleeve: it may get affiliated funds such as Huijin and the pension fund to buy, CSRC may suspend IPOs, insurance companies may be encouraged to enter into the market, MoF may cut stamp duty on stock transactions, and PBoC may announce more easing measures, among other possibilities. However, whether or when these policies can stabilize market sentiment is highly uncertain in our view – margin call pressure from unauthorized margin facilities appears enormous; even for those investors not under any immediate margin call pressure, they need to be convinced that the market will go up meaningfully for their leveraged positions to break even (due to high funding costs).
Deleveraging in the market is likely far from over: margin outstanding only declined moderately from the peak of Rmb2.3tr on June 18 to Rmb2.1tr by July 2. Deleveraging from unregulated margin channels is likely to be more substantial. Nevertheless, looking at the relatively subdued turnover in recent days, we doubt a significant portion of the positions had been unwound. The 10% limit-down rule is delaying a market clearance.
The government to become the buyer of the last resort? All the potential measures mentioned above will largely work on sentiment as direct inflows from these government affiliated entities will likely be moderate by our estimate. If the government fails to turn around sentiment quickly, it may have no choice but to become the buyer of the last resort in the market, similar to what HKMA did in 1998. Even then, things can be complicated: much of the unauthorized margins were used to buy small cap stocks. So the authority, with or without PBoC’s direct involvement, may have to buy stocks on a very large & very broad scale. If and when this happens, it will mark the true market bottom in the short term, in our view.
Even after the fall, the market looks expensive: some short term technical bounces aside after things stabilize, we suspect that the A-share market may enter into a multiyear bear market. The large losses could hurt current investors’ psychology severely and it may be years before the pain fades and/or a new generation of investors with no such bad memory emerges. Meanwhile, SHCOMP is still trading at 17x trailing 12M PER (31x ex. banks), with economic growth stalling and market earnings rapidly decelerating.
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As Deutsche adds,
"so large are the losses for the 20 million accounts opened from mid-April to mid-June that in aggregate no money has been made for 2 years."
Now who could have seen that coming?