A-Share Margin: Gorillas and Grandfather Clocks

After questioning Toyota, as every good investor should right now, I turn my attention back to Chinese A-share margin positions.

In a piece a bit over 2 weeks ago titled A-SHARES: Margin Investors are NOT marginal I pointed out that margin financing had grown faster than the market, and investors were then a very large percentage of the float of marginable shares - about 22-24% at a minimum, assuming margin investors' collateral was marginable stocks only and margin investors were as levered as regulatory possible (this is actually the most conservative calculation). The most recent CSFC data suggests the total collateral for margin borrowing currently stands at 259% (almost all of which is stocks), which means collateral in margin traders' accounts is 21.7% of the float of ALL Shanghai and Shenzhen-listed stocks (marginable and non-marginable), or, if the collateral is only marginable stocks, it is 31% of float. The borrowing itself is 'only' 12% of the float of marginable stocks.

A couple of days before that piece, I had written about A-share valuations, which were somewhat Out of Whack, or worse.

In the 14 trading days since then, Shanghai Composite's market cap is up 13.6%, Shenzhen is up 8.6%, and ChiNext Composite is up 10.3%. Financials in Shanghai are up only a little bit in this period, so Shanghai non-financials are up close to 20% as a basket, putting them at 3.5x book and 28x Operating Profits on a trailing basis. Shenzhen is 5.5x book and 54x OP. Since then, Chinese growth has come in light, exports and trade balance have been extremely disappointing, the HSBC Mfg PMI came in lower (and further below 50) and year-to-date, industrial profits are down 2.7% yoy through March (and banks reported Q1 profits aren't shooting the lights out either). But the PBOC has cut the RRR meaning banks will be able to buy local govt bonds, ever-greening local govt debts, but putting more of the credit risk back into equity investors' hands, and people are excited about SOE mergers (some magic about 1+1 = 2+ while synergies drive costs down? Hasn't anyone figured out that "cost synergies" equals fewer jobs? Will CSR and CNR save on advertising costs? That must be why CSR is 10+x book).

But it's all good. Everyone is buying stocks. Maybe.

CONCLUSIONS: COMPETING FACTORS ARE BANGING HEADS

• MARKET-POSITIVE:
  • New account openings continue to soar. Q1 saw 7.5mm new accounts opened. The first two weeks of April saw an additional 3.24mm new A-share accounts opened. The next two weeks saw the number rise to 7+mm (though some of this could be "extra" accounts after the rules changed to allow as many as 20 accounts per person)
  • IPO approvals will be split into two tranches per month. This spreads out the locked up cash so it does not all come out of the market at once.
  • SOE reforms: Rumours of mergers continue to push stocks up.

• MARKET-NEGATIVE:
  • The CSRC continues to warn investors about blindly chasing the market. And the CSRC also made a point that it would crack down on fraud, manipulation of prices, and insider dealing (where they have pointed out problems exist already). The fraud point specifically mentioned M&A, suggesting that M&A and further asset acquisition/injections will be more carefully vetted.
  • Securities companies are continuing to lower collateralization rates on stocks held on deposit for margin accounts. This week CITIC was in the news with a splash, lowering 25% of the total Shanghai and Shenzhen universe to zero (including CSR), but GF and Huatai also lowered rates (Huatai adjusts most days). This trend indicates declining ability of margin investors to use existing stock positions as collateral, or requires rotation. Rotation requires selling.
  • Technical indicators which look at big swing moves are starting to turn. RSIs have peaked on both price indicators, and many volume indicators. MACDs have started to go negative as well on both prices and indicators. Unless SHCOMP has a good day Monday, it will likely go negative on MACD.
• PENDULUM PUSHING:
  • Margin debt rose by 350bn RMB in the month of April. This is investors borrowing more money BECAUSE stocks went up, raising the value of their collateral account. So they liquidated their positions, started the collateral clock again, and actively borrowed more money against their larger asset base. That is a LOT of new debt. March was 334bn RMB new margin debt. The combined two-month increase in margin debt is larger than the increase in margin debt from the start of the margin system in 2010 through last October.
  • Volume as a percentage of float levels continue to run well beyond the blowout top levels of previous market blowout top events. Margin debt as a percentage of float does too.

Pendulums swing until they don't. Once the pendulum stops its momentum, it takes more incremental force to keep it from moving back than it took to move it to its extended position in the first place. And holding it in place is boring...

That said, if you get a couple of big gorillas to lift up and tilt the grandfather clock sideways, holding the pendulum in place is easier, and it might even continue its previous path if tilted far enough. And it is kind of fun to watch gorillas manhandle grandfather clocks.

Further retail buying could be the gorillas.

And FWIW... investors interested in good governance should pester Toyota about these Model AA shares. These things are bad for Japan.