Pan-Asia Catalysts/Events, Quiddity Advisors

Travis Lundy

Pan-Asia Catalysts/Events

Thematic (Sector/Industry)

This short discussion piece discusses Margin Investors in A-shares. Not valuation. Not flows. But potential - like from high school physics class. This is not a fork on the previous H-Share Mainlanders Buying! <a href="http://www.smartkarma.com/insights/h-shares-mainlanders-buying-h-shares-gone-wild-going-wilder" target="_blank">piece</a>, or the follow-on <a href="http://www.smartkarma.com/insights/h-shares-vs-a-shares-vs-topix-in-whack-out-of-whack-beyond-whacked" target="_blank">look</a> at the relative whackitude of A-share vs H-share valuations. If you want a red bar at the top you can't fork a bullish note, even if the timing is different.Total Shanghai and Shenzhen exchange-registered margin financing on stocks as of the close of trading Monday afternoon (13 April 2015) was RMB 1,671,918,319,975, or US$269 billion at a USD/CNY rate of 6.2.  These numbers look big from one angle, but they are just a day or two's trading value on the two exchanges, and they still a small percentage of Shanghai and Shenzhen total market cap of RMB 53 trillion (US$8.5trln). And the number is short of the US margin debt total (US$465bn). Bloomberg has had a few articles over the past month (<a href="http://www.bloomberg.com/news/articles/2015-04-13/china-walks-264-billion-tightrope-as-margin-debt-powers-stocks" target="_blank">here </a>and <a href="http://www.bloomberg.com/news/articles/2015-04-02/shanghai-traders-make-trillion-yuan-stock-bet-with-borrowed-cash" target="_blank">here</a>).  But the circumstances are different. And the details really do matter.CONCLUSIONS:<ul>
<li>$270bn of margin financing doesn't look so big against an $8.5 trillion market cap, but the Margin Debt is US$270bn, which is deceptively 'low' as a percentage of total market cap, of total financial assets of households, of daily turnover, and other measures. The key word there is "deceptively. "</li>
<li>The actual trading position against that margin financing is, at minimum, 15+% of free float of the entire A-share market, and is likely 22-24% of the free float of margin-eligible stocks (which is 2/3 of China's free float market cap). </li>
<li>The 'liquidity' available to those who need to unwind is the liquidity available from other people playing 'Musical Shares'. The daily trading value of Shanghai and Shenzhen markets has been approximately 7% of free float these last several days - i.e. the entire free float of the market is changing hands at a rate of once every 3 weeks. I do not know of another situation in history where these levels have sustained themselves. The margin position has been built during this 'liquidity bubble.'  There is a lot of money out there looking for the next sucker. And if it can't find it, it may decide it doesn't want to play anymore.</li>
<li>If values traded across the market were to drop to levels of 6-8 weeks ago, the shareholding held against that margin financing debt would be worth 6-9 days of volume. So if 10% of the position wanted to unwind, that would be worth something near a full day's volume, which would pressure the market significantly. If the other people playing Musical Shares also decide to get out at the same time, then there is potentially more pressure. </li>
<li>The flip side of seeing the potential for huge mainlander buying of H-shares because what they can allocate to get in the door is small compared to total HK volume is that the actual amount of flow they can try to execute in their own market is an order of magnitude larger. 10% of the current margin position is 20 days of full Southbound quota limit. </li>
<li>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. </li>
<li>The market is not a two-way market. It is not clear there is a dip-buyer.</li>
<li>Chinese market mechanisms are not equipped to handle an inability to get out of a trade. Limit low means a hit to one's margin account collateral, but no ability to liquidate.</li>
<li>The numbers don't look big but the arithmetic is, to borrow Stan Druckenmiller's adjective, "Horrific." There is train wreck potential in here. </li>
</ul>

This short discussion piece discusses Margin Investors in A-shares. Not valuation. Not flows. But potential - like from high school physics class. This is not a fork on the previous H-Share Mainlanders Buying! piece, or the follow-on look at the relative whackitude of A-share vs H-share valuations. If you want a red bar at the top you can't fork a bullish note, even if the timing is different.Total Shanghai and Shenzhen exchange-registered margin financing on stocks as of the close of trading Monday afternoon (13 April 2015) was RMB 1,671,918,319,975, or US$269 billion at a USD/CNY rate of 6.2.  These numbers look big from one angle, but they are just a day or two's trading value on the two exchanges, and they still a small percentage of Shanghai and Shenzhen total market cap of RMB 53 trillion (US$8.5trln). And the number is short of the US margin debt total (US$465bn). Bloomberg has had a few articles over the past month (here and here).  But the circumstances are different. And the details really do matter.CONCLUSIONS:
$270bn of margin financing doesn't look so big against an $8.5 trillion market cap, but the Margin Debt is US$270bn, which is deceptively 'low' as a percentage of total market cap, of total financial assets of households, of daily turnover, and other measures. The key word there is "deceptively. "
The actual trading position against that margin financing is, at minimum, 15+% of free float of the entire A-share market, and is likely 22-24% of the free float of margin-eligible stocks (which is 2/3 of China's free float market cap). 
The 'liquidity' available to those who need to unwind is the liquidity available from other people playing 'Musical Shares'. The daily trading value of Shanghai and Shenzhen markets has been approximately 7% of free float these last several days - i.e. the entire free float of the market is changing hands at a rate of once every 3 weeks. I do not know of another situation in history where these levels have sustained themselves. The margin position has been built during this 'liquidity bubble.'  There is a lot of money out there looking for the next sucker. And if it can't find it, it may decide it doesn't want to play anymore.
If values traded across the market were to drop to levels of 6-8 weeks ago, the shareholding held against that margin financing debt would be worth 6-9 days of volume. So if 10% of the position wanted to unwind, that would be worth something near a full day's volume, which would pressure the market significantly. If the other people playing Musical Shares also decide to get out at the same time, then there is potentially more pressure. 
The flip side of seeing the potential for huge mainlander buying of H-shares because what they can allocate to get in the door is small compared to total HK volume is that the actual amount of flow they can try to execute in their own market is an order of magnitude larger. 10% of the current margin position is 20 days of full Southbound quota limit. 
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 market is not a two-way market. It is not clear there is a dip-buyer.
Chinese market mechanisms are not equipped to handle an inability to get out of a trade. Limit low means a hit to one's margin account collateral, but no ability to liquidate.
The numbers don't look big but the arithmetic is, to borrow Stan Druckenmiller's adjective, "Horrific." There is train wreck potential in here. 
 

A-SHARES:  Margin Investors are NOT marginal!

Head of China Research - Forsyth Barr Asia, Forsyth Barr Asia

David Millhouse

Head of China Research - Forsyth Barr Asia

Forsyth Barr Asia

Macroeconomics

China Q1 GDP is due out on April 15th, and we see downside risk to the markets 7% forcast. We have written several notes YTD on the downside risks to China growth, and how we believe several more actions are needed to address structural risks which is hindering economic momentum. We expect accelerated easing measures in multiple channels in the near term.

China Q1 GDP is due out on April 15th, and we see downside risk to the markets 7% forcast. We have written several notes YTD on the downside risks to China growth, and how we believe several more actions are needed to address structural risks which is hindering economic momentum. We expect accelerated easing measures in multiple channels in the near term.

CHINA MACRO:  We still expect more loosening near term. 

China

iShares FTSE A50 China Index ETF is an exchanged-traded fund established in Hong Kong. The investment objective of the iShares FTSE A50 China Index ETF is to provide investment results that, before fees and expenses, closely correspond to the performance of A50 Index.

iShares FTSE/Xinhua A50 China (2823 HK)

A-SHARES: Margin Investors are NOT marginal!

This short discussion piece discusses Margin Investors in A-shares. Not valuation. Not flows. But potential - like from high school...

Travis Lundy

CHINA MACRO: We still expect more loosening near term.

China Q1 GDP is due out on April 15th, and we see downside risk to the markets 7% forcast. We have written several notes YTD on the downside risks...

David Millhouse