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Why China’s Stock Market Could Go Ballistic – Then Crash Back to Earth

Why China’s Stock Market Could Go Ballistic – Then Crash Back to Earth
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  • China’s CSI 300 index is going parabolic.
  • State media added fuel to the rally by urging investors to buy domestic stocks.
  • Analysts believe China’s stock market rally will continue for some time before crashing down to more reasonable levels.

After stumbling to a 52-week low on March 23, the CSI 300 – an index of Mainland China’s top 300 stocks – has surged by more than 35%. The Chinese stock market rally has catapulted equity prices to five-year highs.

Goldman Sachs says the party is going to continue, at least for a little while longer. The investment bank predicts the CSI 300 will shoot 15% higher within the next three months before diving lower in the nine months that follow.

This means the CSI 300 could hit a new all-time high of 5,370 by October. The index closed at 4,774 today.

Goldman Sachs sees the CSI 300 surging to 5,370 in the next three months before crashing down to 4,600 in 12 months. | Source: Goldman Sachs via The Wall Street Journal

Here’s What’s Driving the Chinese Bull Market

A price target of 5,370 might seem lofty given how far it’s already climbed, but several factors are pushing the Chinese stock market higher.

The market rally has been fueled by a relaxed monetary policy and the recovering economy. Strategists from Morgan Stanley say this has translated into more retail trading activity.

Morgan Stanley’s Laura Wang and Jonathan Garner wrote in a note:

A Chinese equity bull market is building with rising volumes amid improved earnings visibility and liquidity, plus regulatory/policy support. A-shares are benefiting from strong new fund launches and rising retail investor account openings in the context of regulatory support and an ongoing market reform push.

Not all of that retail investing activity is completely organic, though.

The state-owned China Securities Journal fueled an already exuberant Chinese stock market on Monday when a front-page editorial announced the arrival of a bull market. The paper urged investors to buy equities.

China’s Stock Market Might Be Forming a Bubble

While Goldman Sachs predicts the CSI 300 will go up 15% in the next three months, it expects the Chinese stock index to plunge to 4,600 by this time next year.

There’s ample reason to suggest this feverish stock market rally won’t last. Chinese equities may be forming a bubble like they did in 2015 – when a crash followed a stock market boom.

According to Mark Williams, chief economist for Asia at Capital Economics, there is a long history of policymakers exploiting the media to drive the stock market higher.

It often doesn’t end very well.

As the bubble formed in 2015, state media nakedly urged traders to push the stock market higher. It worked for a while, and valuations briefly hit a seven-year high.

Then the stock market collapsed.

Stephen Innes, chief global markets strategist at AxiCorp, wrote in a note that retail investors aren’t fazed by this history. They’re buying what state media outlets are selling:

It remains to be seen whether we see another repeat of the euphoria of the 2015 Chinese stock market rally, but it certainly seems like retail is happy to buy into it. China’s army of retail investors seem to be perfectly able to look through the worrying Western media headlines of another global coronavirus record; instead, they are listening to the enthusiastic chorus from the nation’s influential state media, which are universally singing bullish from the same song page.

The amount of money borrowed from brokerages to buy stocks has exceeded 1.2 trillion yuan, which Bloomberg says is the highest since late 2015.

Those arguing this time is different point to China’s fast recovery from the pandemic. There were zero new virus cases reported in Beijing on Tuesday, the location of recent outbreak fears. The rebound is evident in the economic data. Manufacturing activity, industrial profits, and retail sales are all recovering aggressively.

The question is whether the euphoria is outpacing the fundamentals. Because if it is, it won’t take long for the house of cards to come down.

As Bocom International’s Hao Hong warned in a recent CNBC interview: In China, the “bull comes as swiftly as it leaves.”

Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com. Unless otherwise noted, the author has no position in any of the stocks mentioned.

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