Bubble Grows Ever Bigger İn China Stocks

Individual investors in China are racing to place their savings in the stock market, but analysts fear the wave of cash could fuel a massive bubble.



With growth slowing in the Chinese economy – the official growth target was reduced to around 7 percent— and with key interest rate cuts in April, small investors in China are on a hunt for yield. 



A large group has fixed on the stock market as the place for their savings, and they are trading shares at record volumes.   



"If you compare the evolution of the composite index of the Shanghai exchange with the evolution of the opening of new trading accounts for stocks "ed only in Mainland China – these are referred to as A-Shares – you soon realize that the Chinese stock market surge is the result of retail investors entering the market," noted Christopher Dembik, an economist with Saxo Bank in a note published on April 20.



"This wave has all the earmarks of a bubble," Dembik pointed out. "You have a large group of retail investors entering the market when it is close to peaking."



The Shanghai Stock Exchange is up 15.9 percent this year, according to a report published by JPMorgan on April 20. 



The market has almost doubled in value over the last six months, and recently rose above the 4,000 mark for the first time in seven years. 



On April 20, the exchange's trading turnover exceeded 1 trillion yuan ($161.28 billion) for the first time in its history.



But Hong Kong is also profiting, thanks to a new scheme that allows both foreign and mainland retail investors to sharply increase their share purchases. The SH-HK Stock Connect Scheme, which began in October 2014, essentially integrates China A-Shares and those of Hong Kong, creating the 2nd largest equity market globally by market cap and turnover, according to statistics on the Goldman Sachs website. 



Close to $4 trillion of incremental market capitalization and 855 companies with above $1 billion of market capitalization will become accessible to investors through Hong Kong.



On April 8, Chinese investors for the first time used up their 10.5 billion yuan ($2.2 billion) "a for trading Hong Kong stocks. The Hang Seng surged to its highest level since 2008 and $HK265 billion ($44 billion) worth of shares changed hands, almost four times the daily average last year. On Thursday, trading volumes were even higher. On Friday, afternoon the index rose 22 points to 26,967.



Analysts say that nearly all this activity was fueled by individual investors.



"Investors in the Shanghai stock market are predominantly retail. The numbers are a bit hard to come by, but we estimate retail investment activity today accounts for about 50 percent of total turnover in Shanghai as compared with 30 percent in Hong Kong or 20 percent in New York, where a larger institutional investor base helps to st: abilize the markets," wrote Zennon Kapron, director of the Shanghai-based financial research firm Kapronasia, in an note on his website dated April 15.



The danger, as Kapron noted, is that prices reach a resistance level and then a correction occurs, with thousands of small investors losing their money. A poll by Chinese authorities released in March showed that a majority of these new investors either cannot read, have limited literacy, or do not have high-school level education.



The Chinese government is taking steps to reduce this kind of danger.



The National People's Congress announced a revision to securities law on April 23. Measures are being taken to protect the retail investor, who currently comprises the majority of investors in shares. These will include reinforcing transparency and cutting down on red tape for the small investor, the NPC said.



Nonetheless, as Kapron observed, there is real danger for many of these investors given the volatility of today's markets.



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