In less than a week, the retail-dominated China A-Share market has triggered two circuit breakers in the first four trading days of 2016. On 4 January and 7 January, the onshore Chinese market as represented by the CSI 300 Index fell more than 7% respectively in a single trading day, bringing the stock market to an early close. Given there has been no material deterioration in terms of China's economic fundamentals over the week, the latest economic indicators were largely within consensus expectations, the latest sell-off appears to be driven by sentiment and knee-jerk reaction by domestic speculator which has sent the market –11.38% lower by the end of the first week of 2016. Global financial markets were also rattled with the likes of the US, Europe and Singapore dropping –5.96%, -6.5% and -6.2% respectively (in local currency terms as of 8 January 2016).
In this article, we identify three possible reasons which could have soured sentiment and triggered the sell-offs: 1) continued RMB weakness; 2) expiration of stock sales ban; and 3) mechanism of the circuit breaker on CSI 300 Index.
1) Continued RMB Weakness
The People's Bank of China (PBOC) shocked the markets as it allowed RMB to depreciate further against the USD to the lowest level since March 2011. The PBOC set the yuan midpoint rate at 6.5646 per dollar prior to the onshore market open, -0.5% weaker than the previous fix of 6.5314. As a result, the market widely regarded the latest move as a competitive devaluation to bolster the faltering economy. This has triggered fears of capital outflows from China on deepening concerns about the economy, weakening investor sentiment as the news came to light.
2) Expiration of Stock Sales Ban
As a measure to arrest the stock market meltdown in the middle of 2015, China's securities regulator had stepped in to stabilise the stock market by banning major shareholders, corporate executives and directors from selling stakes in listed companies for six months in July last year. The expiration of the ban on 8 January has led to speculation that major shareholders, corporate executives and directors would be unwinding their positions after the ban was to be lifted, causing much jitters among the Chinese.
3) Introduction of Circuit Breaker Mechanism on CSI 300 Index
A circuit breaker refers to measures put in place to avert panic in markets by putting temporary halts in trading, should the index fall by a pre-determined level. In China, the circuit breaker system is tied to the CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen. The proposed mechanism is designed such that a -5% drop in the index will trigger a 30-minute trading halt; with a further -2% drop resulting in the close of the market immediately for the rest of the trading day. While such mechanism was meant to create a more stable equity market (in a market that is dominated by retail investors), it has triggered the opposite effect instead. One major problem with the design of the circuit breaker mechanism in China: the gap between the two breaker levels is not wide enough. In comparison with a mature US market (less volatile market), the breaker levels are set to be far wider at 7%, 13% and 20% for the S&P 500 Index. This is to avoid a "magnet effect" as seen in China yesterday, where hitting the initial breaker level has triggered a rush towards more selling subsequently, instead of having a calming effect.
Reactive Measures from the China Securities Regulatory Commission
Following the nosedive in Chinese equities, the China Securities Regulatory Commission (CSRC) has suspended the circuit breaker mechanism starting 8 January 2016, taking into consideration fund houses' requests to revise the mechanism. The stock sales ban restrictions were also revised by the regulator. Major shareholders are now only allowed to sell not more than 1% of total shares outstanding within three months, with such intended disposal to be disclosed to the exchanges 15 trading sessions in advance. The CSRC has also mentioned that these initiatives are aimed to stabilise the market and would be willing to do more should the market continue to be volatile.
Our Expectations and Views on China's Market
1) A lack of clarity on the revised circuit breaker mechanism or other related measures will continue to pose a short term risk to the Chinese equity market.
2) A quick reminder to our investors regarding the China funds on our platform is that they invest mainly in the China H-Share market. As such, the less volatile nature of China H-Shares should help to cap downside risks on its share prices moving forward (which has retreated -8.21% compared with -11.38% in China A-Shares over the week). Valuation wise, China H-Shares remains attractive, with the HSML100 Index trading at 8.43X PE based on 2016 estimated earnings, which is a significant discount to the fair PE ratio of 13.0X. We maintain our favourable view on China's H-Shares on the back of an expected stabilisation in China's economic growth as well as its cheap valuations. We view that the recent sell-off as a good opportunity for investors to gain exposure to China H-Shares on weakness.