“Ok, I’m here. What’s the problem?”
“Well, sir, it’s the stocks.”
“What about the stocks?”
“They won’t stop falling.”
“Have you tried threatening them?”
“The stocks?”
“The people selling them.”
I don’t know exactly how it’ll go when Xi Jinping meets with regulators to discuss China’s never-ending equity bear market. Probably not quite like the satirical exchange “quoted” above. But if it’s good ideas China’s bureaucrats are looking for, they’re not going to get any from Xi. On the contrary, Xi’s the proximate cause of the crisis.
According to the ubiquitous “people with knowledge of the matter” who spoke to Bloomberg (and we all know how reliable Bloomberg’s “people” in China have been when it comes to signaling a bottom in local equities), authorities, including the China Securities Regulatory Commission, were set to brief the big man “on market conditions and the latest policy initiatives” as soon as Tuesday.
Both Mainland and Hong Kong shares dutifully soared. Small-caps were especially elated. The CSI 1000 rose the most since 2008.
That put the brakes on a truly disconcerting selloff. The CSI 1000 careened more than 6% lower on Monday alone, capping a seven-session swoon that summed to (get this) around 20%!
In other words (and as the figure above shows), the seven-day rout in Chinese small-caps was the largest ever outside of the financial crisis and the 2015 equity crash (inclusive of its aftershocks).
Officials in China are particularly worried about smaller shares. Headed into this week, they were underperforming the CSI 300 by 20ppt in 2024.
That’s really saying something considering China’s large-caps weren’t exactly off to a great start in the new year.
The CSI 1000 is apparently the reference for snowball knock-ins and the deep losses suggest investors in those products are bleeding. Reports also indicate that quant funds probably accelerated the small-cap rout, prompting the CSRC to ban some sell orders. The regulator also placed restrictions on a leveraged strategy linked to losses for shares of smaller companies.
While specific products and strategies surely played a role, a simpler explanation for the crisis in small-caps is that investors assume, based on previous experience with the vaunted “National Team,” that state rescue measures will focus primarily on big companies. So, they aren’t especially excited about catching the falling knife in small ones.
After issuing a series of threats (some veiled, others not so much) over the weekend, the CSRC on Monday claimed it found evidence of “malicious short-selling.” Assuming they weren’t just making that up (i.e., assuming the CSRC actually did identify some scapegoats), you wouldn’t want to be the accused.
Other measures adopted by authorities over the past 48 hours include severe curbs on access to total return swaps (which works both to prevent Mainland market participants from betting against stocks in Hong Kong and limits selling of Mainland shares by offshore subsidiaries of Chinese brokers) and restrictions on securities lending. Just hours before Bloomberg reported the imminent sit down with Xi, Central Huijin — a warehouse for the Party’s big-bank investments — said it’ll keep buying ETFs.
This is all plainly insane on at least one level. As noted in these pages time and again, this is first and foremost a crisis of confidence in Xi, both among domestic and overseas investors. Geopolitical tensions are a headwind and the Chinese economy has a long list of problems to address, but by and large, those issues are likewise attributable to Xi’s policies.
Ultimately, stocks’ free fall can be traced to the suspicion among market participants that the leadership is so capricious — predictable only in being unswervingly obsequious to the vagaries of Xi’s “Thought” — that no discount is sufficient to compensate investors for the risk that at any given moment, Xi’s domestic social agenda, economic policies, attitude towards foreign capital or geopolitical vision could manifest in additional large losses.
You can be sure that whatever’s said to Xi during Tuesday’s briefing on the market rout, no one will endeavor to suggest that he’s the problem.
This seems like a naive question, but here goes. Suppose China simply banned all securities other than vanilla long equity. No options, no swaps, no derivatives of any sort, no short-selling, etc. You can buy and sell common shares and that’s it. What would happen, short and long-run?
I wonder this not because I’m suffused with sympathy for the CCP’s PPT, but partly because I don’t really understand what useful function derivatives serve, and partly because that might be the logical direction of the restrictions announced to date.
JL – I’m with you on that question. But suggest any restrictions on short selling you will bring the wrath of the market purists will descend upon you. How dare you suggest anything that will inhibit short-term speculators!
But worry not, our friends on the street will just offer more offshore products so you can continue to drive Chinese stocks lower.
derek, can you give me the TL:DR on how those offshore products work and if/how the CCP can shut them off?
More generally, I’m thinking Xi’s inner circle is probably not full of market purists. Perhaps they are inclined to see derivatives etc as “low-quality” market activity, as corrosive Western influence like low-cut jeans and feminism, or even as “threats to security”. Maybe bans like those mooted above are not as unthinkable to the Xi-men as they are in the US. If so, there’s at least a outside chance that we could wake up and find the “undesirable” parts of China’s securities market – you know, the selling part – headed for “lockdown”.
For your answer to that question refer to the Gulf exchanges, Dubai bans short selling due to religious reasons.
I believe short-selling is currently banned in South Korea.