China Equity Markets: The past and the future


This Jan 2017 might be a good time to look back at the last year where China's stock market was going wild with extreme volatility and record trading volume.
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The stock market plunge prompted Chinese regulators from Beijing to contain the panic and fear among investors. Among the tools used by regulators is to adjust interest rate, changing stock trading regulations, loosen margin credit to prop up the falling market and many more actions deemed as brute force. There is too much similarity in interpreting market information among investors. They are speculating heavily in the market by not using any fundamental basis. They are skeptical of all actions made by the regulators and regulators are in a tight situation in order to be impartial. Investors are extremely scared of further markets actions that might impact the value of their shares and there will be further wave of irrational purchase and sales of shares.
Regulators responded by using the most direct approach which is approving large funds or stimulus to buy up huge amount of shares in proportion to the average trading volume. Beijing regulators had exerted its influence and control over its entities under the supervision by buying all shares up till the panic is over and subsided. Fear can only be removed by explicitly ordering all institutions to stop selling and buy continuously until a new order is issued. There is no other better signaling move. Regulators in fact chose this path and managed to ease the fear which sparked a rally for the markets.
The unconventional forceful method of propping up the market, accompanied by the surge could mean further rise of more serious fall. It could go either way and market will be extremely brutal to speculators. Investors will never be able to fully comprehend the complexities of regulatory behavior and market starts to behave in other ways as we slowly understand the impact. Market is always forward looking and will reflect all interpretations of the collective investors.
Many market watchers have differing opinions as to the effectiveness of the control measure in terms of size and importance. However there is one specific action that will send a very clear signal to the market, which may well be the most widely covered methods for rescuing the markets. The action includes a meeting involving 21 leaders of China's largest brokerage firms with CSRC, the powerful market regulator. The outcome of the meeting was an official statement by all parties that they will collectively spend 120 billion yuan to stabilize all parts of the equity market by buying exchange floated funds tied to high grade blue chip shares that are trading on Shenzhen & Shanghai markets.
The firm had unanimously agreed to continue holding on all the stocks purchased in the open market with their internal funds until the stock index benchmark recovers to a comfortable level at 4,500 index points. Brokers are holding on to huge amount of shares that could be offloaded any time as soon as the opportunity arrives. Regulators have restricted the selling until at least the index reaches a level at 4,500 points. There is a big resistance level at 4,500 levels and no market observers could foresee or forecast the impact. This in essence acts as a similar call option that buyers must forgo when the purchase stocks when the index trades under 4,500. As the stock index closes in at 4,100 or much higher, there will be heavy selling by brokers who are cash-strapped and running out of capital at index level of 4,500. Investors who bought shares are providing a free of charge call option at 4,500. As prices trend higher, upside is capped and downside risk becomes more apparent.
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