Chinese stock markets took heavy losses on Friday as the Shanghai Composite index fell by almost 20% from its recent peak. The smaller but equally important Shenzhen Composite Index fell by 7.49% on Friday to be 20% off the highs it had reached earlier in June.
The boom on the Chinese markets has largely been fuelled by the stimulus measures announced by China’s central bank in November last year. This has resulted in markets being as much as 60% up, buoyed by local investments. The fact that many of these investors have borrowed heavily from their brokerages in order to join the rush for shares in a decidedly bull market is causing great concern as prices fall rapidly in a short time. The Shanghai Composite Index reached its highest levels since the global financial crisis on the 12th of June, only to have fallen by almost 20% on Friday.
Supplementing the earlier stimulus measure introduced by the central bank, new easing measures such as removing the cap on the commercial bank loan-to-deposit ratio and introducing additional liquidity into the financial sector, investors were still not satisfied.
The prevailing sentiment is that more potent measures, such as a cut in the reserves required by banks, are being sought. Thursday saw the first injection of liquidity into the system by the central bank in 10 weeks, but this had no effect with the markets dropping further.
Analysts at Morgan Stanley are of the opinion that the falling prices are not a dip to buy. Chao Deng, writing for MarketWatch, is very much of the opinion that the Chinese markets are plunging towards bear territory.
The selloff in stocks has been hardest felt by the higher risk startups, an indication being the drop in the ChiNext Price Index which closed 8.95 % down. This has resulted in a total fall of 27% from its record close on 3 June 2015.
Morgan Stanley analysts also expressed their concern after lowering their target price for the Shanghai Composite Index in a report released on Thursday. Excessively high valuations as well as a high margin debt relative to the total free float capitalization are additional areas of concern. Margin debt, which results from brokerages financing the speculative investments of their clients, has reached 8.5% of the total value of China’s tradable shares, which is unsustainable in a falling market.
The other uncertainties facing world markets such as the Greek financial crisis have also had their effect on the markets in China in keeping with the rest of the world's markets. Clarity or some form of finality, even if it is a Greek exit from the Eurozone, will bring a degree of stability back to the markets. In the interim, it will remain very much a wait and see situation.