China’s Bear Market: An Investor Crisis Or Opportunity?
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China’s stock market has officially spiraled into a nauseating yet highly-anticipated bear market after more than doubling in the past 12 months. Whether investors see a crisis or opportunity depends on their faith in the government and central bank. On one hand, investors can take solace in cheaper valuations and that China’s leaders will keep throwing the financial system a lifeline via rate cuts or other stimulus. On the other hand, they fear the past year’s rally was artificially fueled by borrowed money and loose monetary policy that will give a heinous hangover to those who leave the party too late.

China’s stock market continues to be dominated by speculation, says Russ Koesterich , global chief investment strategist at BlackRock. Even after the recent sell-off, margin debt remains near to an all-time peak. And despite a correction, stock valuations are still high relative to a year ago, he wrote in a commentary Monday.

The sell-off the past two weeks prompted China’s central bank to apply emergency monetary CPR over the weekend. The People’s Bank of China cut one-year lending and deposit rates by 0.25% to 4.85% and 2%, respectively. It marks the fourth such cut since November 2014. The one-year lending rate is now 0.46% lower than its prior low of 5.31% during the 2008 global financial crisis. The one-year deposit rate is the lowest since 2004.

The PBoC: Doing What’s Right for China

The PBoC also cut the required reserve ratio, RRR, for banks by 0.5% and for financial companies 3%. This is expected to pump 430 billion yuan, about $69 billion, into the market.

“It suggests that the government sees the urgent need to stabilize market sentiment and to reduce risks,” Bank of America Merrill Lynch’s analysts Xiaojia Zhi and Sylvia Sheng wrote in a report released Monday evening. “It sends a clear signal of continued monetary easing, dismissing market concerns of a possible change in PBoC stance.

“It helps to lower risk-free rates and financing costs, supports liquidity and credit supply, and lowers debt service burden for borrowers.”

Zhi and Sheng wrote the interest rate and RRR cuts were positive for the economy and necessary for four reasons:

“1. Domestic demand is still weak and we are yet to see clear signs of growth recovery. Though May data improved on the margin, major high-frequency data in June weakened again.

2. Inflation is still very low: CPI (Consumer Price Index) at 1.2% and PPI (Producer Price Index) deeply negative at -4.6% and another negative gross domestic product deflator likely in the second quarter.

3. Lending rates are still undesirably high, especially in real terms, curbing investment demand while interest burden remains heavy. The average nominal rate for new bank loans was 6.16% in May, 91 basis points (0.91%) lower from a year ago. But in real terms (deflated by CPI), it would be 4.9%, similar to the average rate in 2014 and higher than 4.35% in 2012-13.

4. To ensure financial stability after a 20% correction in A-shares in two weeks.”

The lending rate is still extremely high at 4.85%, and more rate cuts are likely, say Credit Suisse’s analysts. China’s economy suffers from a lack of credit and excessively high-interest rate, they believe.

“We think that the central bank is likely to abandon the loan-deposit ratio as a restriction to commercial banks’ lending activities, possibly in fourth quarter 2015 or first quarter 2016,” Credit Suisse analysts wrote in a Global Economic Quarterly report released Friday. “Further deregulation in interest rates seems to be on track, following the launch of the deposit insurance scheme and deregulating interest rates for large deposits.”

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