China equity markets boom while economic growth stutters

Just what is going on in the Chinese stock market? There is a frenzied feeling about the equity market, where a world-beating rally has seen the benchmark index rise to its highest level in seven years.

It is such a strong performance that a brokerages boom appears to have added more than half a percentage point to Chinese GDP in the first quarter as equities turnover surges.

The Shanghai Composite Index rallied 90 per cent in the past 12 months and, in one week at the end of March, Chinese investors opened a record 1.7 million equity-trading accounts. There is now more than 1 trillion yuan (€150 billion) of borrowed money in the Chinese stock market.

As the markets boom, the overall economy is seeing slower growth. GDP data last week showed that real GDP rose by 1.3 per cent in the first quarter and by 7 per cent in the year.

Diana Choyleva at Lombard Street Research believes China's real GDP fell by 0.2 per cent in the first quarter, the worst since the global financial crisis, while real domestic demand plunged by 2.1 per cent, the worst since LSR data began at 2004.

Fuelling the equities boom is margin trading, where investors borrow most of the money from a brokerage to buy shares.

To fears of local government debt and shadow banking in China, you can add anxiety about what happens when share prices fall and investors have to sell their equity holdings to repay their debts.

"The frenetic opening of trading accounts and a surge in equity turnover have produced a boom for brokerages that appears to have added more than half a percentage point to China's GDP growth last quarter," says Mark Williams at Capital Economics.

“Leaving aside the wider repercussions, any cooling of enthusiasm for equities would create a sizable drag on GDP.”

Turnover on the Shanghai and Shenzhen equity markets was equivalent to just under 300 per cent of GDP last quarter, more than three times the rate a year before.

“With the stock market being driven by sentiment, rather than any improvement in underlying economic conditions, there must be a high chance that turnover and investor enthusiasm cool,” Williams adds. “But even if equity turnover and related activity simply stabilised at current elevated rates relative to GDP, this would result in a sharp drop in the financial sector’s contribution to the growth of GDP.”

Fund manager Mark Mobius, who oversees $37 billion as executive chairman of Templeton Emerging Markets Group, still believes the bull trend is intact in China. However he reckons the stock market has risen too fast and that a 20 per cent decline is "very possible."

"It has gone a little too far and too fast," Mobius has told reporters in Hong Kong.

He is also worried about the credit question. “Too much credit is not a good thing in the long run,” he adds. “When the market turns, it could be a problem.”

Li Yong at the Hanqing Advanced Institute of Economics and Finance at Renmin University has also said he thinks the stock market is growing too fast.

“What long or short trading needs are excuses. Now the excuses and the tool already exists and many new stock investors who know nothing about stocks have entered the market,” Li says. So the stock market is in danger now and it doesn’t look good for the stock market in the short term.”

When Chinese shares eventually join the Morgan Stanley Capital International indexes, that will also fuel a longer-term upward trend.