A-SHARE QUICKNOTE | A Bag-Holding Exercise Has Begun

What had the best Information Ratio in the world over the last year as of last Friday?

Possibly Shanghai Margin Debt Balances... +464% in 1 year on volatility of 12.5%.

As noted in the last piece on A-Share Margin Investors almost a week ago, after the worst week A-shares had seen, there was money due to come in off IPO funding lock-up early this week. It came in, helping A-shares up 2+% both Tuesday and Wednesday. Thursday morning brought the news that China had proposed (subject to ratification at the Standing Committee of the National People's Congress (next March?)) lifting a cap on banks' loan-to-deposit-ratio. This should have been seen as bullish, as it has similar effects to a forward RRR cut. But after dilly-dallying Thursday most of the day, share prices plummeted 4% into the close (with small caps falling even more). It is not clear what this was blamed on. On Friday, Shanghai Composite fell in the morning, and then fell the rest of the day, ended -7.4%. Shenzhen Composite fell 7.9%, and ChiNext fell 8.3-8.9% (Price, Composite respectively). This was, in some stories in the local press, blamed on people thinking margin investors were bailing because the data showed 4 straight days of margin balance reductions.

To be sure, margin debt fell this week. Shanghai Long Margin position balances were -6.2%. But Margin Debt as a percentage of MarketCap, and Free Float, rose to record highs on Friday in Shanghai. The ongoing high margin debt to float means that the market can continue to get pushed to the downside. As pointed out in the original Margin Investors are Not Marginal, "If the market goes down sharply for whatever reason, there will be margin calls. The door is simply not big enough to let all of them out. The numbers don't look big but the arithmetic is, to borrow Stan Druckenmiller's adjective, "Horrific." There is train wreck potential in here."

Sure Friday was down 7.4% (SH) and 7.9% (SZ), but the week as a whole didn't look too train-wreck-y as stocks were 'only' down 6.4% (SH) and 8.7% (SZ). China's biggest IPO in years continued its streak of limit up days every day this week, and some 65% of Shanghai margin names saw margin debt as a percentage of free float increase this week (people cut, but some responded to margin calls with more collateral). Friday was actually worse than it looked though as 82% of Shanghai-listed shares which traded ended limit down. For Shenzhen the number was 88%. If they had been allowed to continue to fall, it could have been a lot worse. And that ignores the fact that 10% of Shanghai listed stocks and 17% of Shenzhen-listed stocks were in trading halt for one reason or another yesterday. And that biggest IPO discussed here three weeks ago saw some serious action, leaving me to think Monday will not be a good day for the stock.

It's not clear if Official China is coming to the market's rescue.

• CSRC spokesperson Zhang Xiaojun said in a regular Friday press conference "[The] recent sharp setback of stocks listed on China's A share market is [a] natural phenomenon" and "the liquidity in the market is still ample." Given that the market has just had its worst 2-week period in 20yrs and 10-day realised volatility is above 60%, highest since 2008, that is likely not what the market wanted to hear.
• As noted half-jokingly last week, the PBOC can always come in. It didn't last week. But today Saturday, as I finish this writeup, the PBOC cut rates and lowered RRRs for some banks.
• And Shenzhen-HK Connect could be announced imminently I expect.

CONCLUSIONS

• Margin positions are not decreasing as a percentage of float. This means that, on average, margin investors are putting money into supporting existing positions, not reducing debt or leverage as high volatility and market declines create holes in their accounts. The data from last week shows rotation from recent winners to losers. From large caps to small caps.
• The CSRC spokesperson says liquidity is ample, but trading value as a percentage of market free float is near its lowest in three months, just as margin debt as a percentage of free float are their highest ever. And over 80% of Shanghai Composite stocks which traded Friday ended limit down. Obviously more liquidity was sought.
• This could get messier. Think Gorillas and Grandfather Clocks. The gorillas have manhandled the grandfather clock, but the pendulum didn't want to swing further than they pushed it. Now they are unhappy and are shaking the clock around.
• The official press and agencies have spoken volumes with their silence. The stories in the papers near-term will likely be unhappy ones - not stories celebrating Shanghai being up 30% and Shenzhen Composite +77% year-to-date.
• More new A-Share accounts have been opened since we went up through current levels 10 weeks ago than in the two years before that.
• And unfortunately, on average A-shares are still not cheap. The median stock on Chinese exchanges is 85x earnings says Bloomberg - higher than the 2007 peak.
• A Significant Bag-Holding Exercise has begun.