Earlier today in “Panic: China Central Bank Steps In To Bailout Stocks As Underwater Traders Pray For A Rebound,” we noted (without much surprise) that the PBoC has officially taken the plunge. Late on Sunday, the China Securities Regulatory Commission announced that China’s central bank is set to inject capital into China Securities Finance Corp which will in turn use the funds to help brokerages expand their businesses and reinvigorate stocks. Translation: China’s central bank is now underwriting brokers’ margin lending businesses.
Although Beijing will surely contend that this does not amount to Chinese QE because the central bank isn’t actually adding equities to its balance sheet (or at least as far as we know), it certainly sounds as though the PBoC is now set to directly fund leveraged stock purchases by retail clients and if that doesn’t count as using the central bank’s balance sheet to monetize risk assets then we don’t know what does.
The move came after a consortium of brokers agreed on Saturday to commit 15% of their collective net assets to propping up China’s flagging stock market. The amount of support sums to just $19 billion and will be allocated to blue chip stocks, meaning, in no uncertain terms, that the initiative will be woefully inadequate to combat the rapid unwind of hundreds of billions of off-the-books margin trading.
And so, the fate of the market now lies squarely in the hands of the PBoC who, as BofAML notes, may have just “crossed the Rubicon.”
As we argued before, the A-share market may not bottom until the government, possibly via the PBoC, becomes the buyer of the last resort. It seems that the government might have just taken the first step in that direction on Sunday night with PBoC’s promise to provide liquidity support to stabilize the market. We expect the A-share market to rebound somewhat in coming days, especially large cap names. If that happens, we suggest investors sell into the rally, especially brokers. Fundamentally, with SHCOMP ex. banks trading at 31x trailing 12-month earnings, the market appears very expensive to us. We assess that there is still a fairly high chance that market may fall sharply again at certain point over the next few months, unless the PBoC makes an open-ended commitment to support the market.
What the government did over the weekend
Among the many things announced over the weekend to support the market, three are meaningful, in our view: 1) a de facto suspension of IPOs in the A-share market; 2) the set-up of an Rmb120bn market stabilization fund (MSF) by 21 major domestic securities houses, coordinated by the CSRC; and 3) the
PBoC’s promise to provide liquidity support to China Securities Finance Corporation (CSFC). CSFC is the clearing house for margin financing and stock lending businesses in China and it’s also the sole provider of margin financing loan services to securities houses. Among the three measures, the third is by far the most important in terms of potential impact on market psychology by our assessment - we doubt that the first two alone would be able to stop a potential market rout on Monday.
Has PBoC crossed the Rubicon?
CSRC’s announcement on the liquidity support does not spell out how the liquidity will be used by CSFC, nor does it say anything about the size of the potential support. We suspect that the initial PBoC loans to CSFC will be used on Monday morning to fund the MSF until brokers’ funds arrive (by 11am on Monday as ordered by the CSRC). Local media reported that CSRC is confident of Rmb1tr inflows into the A-share market in short order. So it’s also possible that PBoC might have committed to provide a few hundreds of billions of Rmb for the time being by our assessment, with the balance of the inflows potentially coming from pension funds, insurers etc. At this stage, it doesn’t appear to us that PBoC is prepared to buy stocks itself or make its commitment to provide support open-ended.
While we would certainly agree that the PBoC has indeed "taken the first step in the direction" of becoming the buyer of last resort, we're not so sure the distinction between the central bank "buying stocks itself" and providing the funds for brokers to facilitate margin trading is very meaningful.
The central bank is effectively monetizing risk assets — the fact that the buyers are one degree removed from the PBoC is largely just a matter of optics. Also, we're not at all sure that the central bank will not move very quickly to make its support "open-ended" — as discussed here on any number of occasions, Beijing simply cannot afford a stock market crash and thus will not go down without a fight.
All of that said, the market's reaction to what the PBoC probably thought would be a potent one-two punch (the simultaneous cut to both the benchmark lending rate and the RRR rate) was met with still more selling, which is of course just another example of central banks losing control (see Sweden for further evidence). On that note, we'll close with the following warning from BofAML:
If PBoC becomes the main source of market-supporting liquidity, we expect the central bank's credibility to be hurt.