Two weeks ago, in “The Cost Of China's ‘Manipulated Market Stability’ May Be Too High, BofAML Warns,” we revisited Beijing’s plunge protection national team, which during Q3 bought an astounding CNY1.5 trillion in stocks.
For those who might have forgotten exactly how this worked, the PBoC effectively transformed CSF into a giant, state-run, margin lending, prop desk and before you knew it, the government was stepping in just prior to the close on a near daily basis to keep the bottom from falling out. Every time CSRC attempted to step out of the market, chaos ensued. Indeed, even rumors that the government was preparing to scale back the plunge protection were enough to spook investors as we saw in late July when futures sank after a Caijing reporter suggested that the national team was set to rein in its purchases (that reporter was later arrested and charged with causing “panic and disorder”).
As August wore on, the cost of propping up the market (which desperately wanted to fall further as legions of semi-literate Chinese day traders who three months earlier had been willing to buy any and all dips suddenly had a mind to sell any and all rips in a frantic attempt to salvage their severely depleted life savings) simply became unbearable and so, Beijing decided to just start arresting anyone who was suspected of being a “malicious” seller. The crackdown - named “kill the chicken to scare the monkey” after a Chinese proverb - was designed to essentially make market participants believe that selling or worse, shorting, could land you in jail.
Subsequently, the market stabilized but by the time the waters calmed, China was left with an enormous stock portfolio, nearly a quarter of which was purchased at multiples above 40X.
Here's a look at the paper losses the government had incurred by the end of September (note that most of the CNY224 billion hit had been recouped as of mid-November):
BofAML's conclusion was that given concerns about what incessant stock buying might convey about both the future course of the yuan and about China's commitment to liberalizing capital markets, the PBoC may not be inclined to remain active in the market going forward.
Indeed, when the SHCOMP plunged on Friday in the aftermath of a new round of broker probes, a poor read on industrial profits, and the revelation that two more companies are set to default, the national team appeared to have stayed on the sidelines and maybe that's a good thing because as FT reports, the government now owns 6% of the entire mainland stock market.
"China’s 'national team' owns at least 6 per cent of the mainland stock market as a result of the massive state-sponsored rescue effort this year to prop up share prices following the summer equity market crash," FT wrote on Thursday, adding that "China Securities Finance Corp, the main conduit for the injection of government funds, owned 742 different stocks at the end of September, up from only two at the end of June." Here's more:
The figures are compiled from quarterly financial statements of listed companies, which are required to disclose their 10 largest shareholders. The actual size of national team holdings is probably larger, given that some likely hold stakes that are too small to rank among the top 10.
The estimate of the shareholdings of the national team covers positions held by CSF, which is the state-owned margin lender, and by Central Huijin Investment, the holding company for shares in state-owned financial institutions and a subsidiary of China’s sovereign wealth fund.
The market value of CSF’s holdings increased from only Rmb692m ($108m) at the end of June to Rmb616bn three months later. However, the market value of Huijin’s holdings fell by Rmb167bn in the third quarter to Rmb2tn, mostly reflecting mark-to-market losses on shares it previously held. This fall came despite Huijin’s additional share purchases in the period.
The significant role of the national team in propping up the market has raised concerns about the sustainability of the recent share rally, and about what would happen if the government unwound its holdings.
Yes, "what would happen if the government unwound its holdings?" That's difficult to say, but it might very well be that the psychological effect national team selling would have on market participants would end up doing more damage than the selling itself.
As we discussed earlier today, it looks like China may be trying to offset a rollback of the draconian measures imposed on markets over the summer by throwing more people in jail. That is, in an effort to dispel the idea that the Politburo controls what goes on in markets, Beijing is lifting some restrictions. But that means losing control and so, officials hope a renewal of the "malicious" market manipulator witch hunt will be able to keep things in check. Here's an example of what we mean: just days ago, Beijing lifted selling restrictions on brokerages' prop desks, but simultaneously, authorities launched investigations into at least three brokerage houses for alleged "rules violations." As we put it earlier: so you can technically be a net seller again, it's just that you might end up being arrested for it if the Party thinks your selling was particularly malicious or otherwise ill-timed.
This all comes as the country is facing its "Minsky Moment" wherein heavily indebted corporates will no longer be able to borrow money to pay interest on money they borrowed in the past. Once that threshold is crossed, the defaults begin.
Throw in rapidly decelerating growth and an acute over capacity problem and there's the very real potential for concurrent crashes in stocks, bonds, and the overall economy.
So time will tell whether Beijing will ultimately be satisfied with 6% of the equity market if things start to go south again as they did today and whether, when missed principal and interest payments are happening six times per week instead of six times per year, Xi will be able to keep his cool and refrain from bailing out the entire commodities and industrial complex at the expense of China's international reputation.