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China’s Siren Song Of Speculation

China’s Siren Song Of Speculation by Cook & Bynum

As China’s stock market continues to rise, the siren song of speculation is proving too much to resist for many in China.  Using debt in a variety of forms (beyond just typical margin loans), corporations are piling in – for many manufacturing concerns, the overwhelming majority of recent profit growth is attributable to gains in investment portfolios.  Given the type of participants and the huge amounts of leverage in place, a correction could create a cascade that is disruptive to all parts of China’s capital markets.

Take Dong Jun, who earlier this year shut down his factory making lighting equipment and electrical wiring and let go some 100 workers. The 50-year-old comes to the plant in the eastern city of Yancheng almost daily, but spends his time trading stocks on behalf of his company, Yanwu Keda Electric Co. “Manufacturing is a very hard business these days,” said Mr. Dong, chairman of the company. “I want to make some money from the stock market and use the profits to restart my manufacturing business later, when the economy turns for the better.”

Chinese companies are finding stock investing an attractive option as the wider economy struggles with tepid demand, excess industrial capacity, persistently high borrowing costs and other troubles. Their interest poses a challenge for policy makers, who want to nurture markets companies can tap for investment capital, rather than creating a venue for speculation. “The stock market is a big risk for China’s economy because the current rally isn’t supported by the economic fundamentals,” said China economist Zhu Chaoping at UOB Kay Hian Holdings Ltd., a Singapore-based investment bank. “Regulators will have their work cut out for them keeping the market in check.”

According to the latest official data, profits earned by Chinese manufacturers rose 2.6% from a year earlier in April, a turnaround from a drop of 0.4% in the previous month. Yet nearly all of that increase – 97% – came from securities investment income, data from the National Bureau of Statistics show. Excluding the investment income, China’s industrial profits were up 0.09%. Meanwhile, over the course of 2014, the value of stocks, bonds and other tradable securities owned by listed Chinese companies rose by 946 billion yuan ($152.4 billion), a 60% increase, according to an analysis by Mr. Zhu.

The trend is starting to worry Chinese regulators, who have been trying to make sure that banks and the stock markets ultimately channel money into parts of the economy that create jobs. Even more problematic, according to some officials, is that the rush by companies to tap the market for easy gains now – sometimes using borrowed money to purchase stocks – could leave some scrambling for capital if the market turns. On Friday, China’s top securities regulator said it is tightening supervision over the use of borrowed money, or margin financing, for stock trading.

The recent market rally, which started late last year, was partly set off by moves by the Chinese central bank to ease credit, including three interest-rate reductions since November, and investors’ expectations for more efforts to spur growth. The benchmark Shanghai Composite Index is up 51% this year, and 134% in the past 12 months; for the smaller, more volatile Shenzhen exchange, the respective gains are 109% and 173%. The bull run, however, seems decoupled from how the world’s second-largest economy is doing. In the first four months of this year, state-owned enterprises, the backbone of the economy, have seen profits shrink 24.7% from a year earlier, while earnings in the private sector increased 6.1%, down from more than 10%.

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China CITIC Bank Corp. is the most aggressive in lending to brokerages to help them finance their margin-financing businesses, according to an analysis by Reorient Group, a Hong Kong-based investment bank. Loans made to brokerages for that purpose totaled nearly 913 billion yuan in the first quarter, up 92% from a year earlier, the firm’s study shows. “Banks are happy to channel liquidity to brokerages as a way to participate in the stock rally,” said Steve Wang, head of China research at Reorient.

In a response to The Wall Street Journal, Citic attributed the jump to an “increase in investment in asset-management schemes for securities firms,” loans made by the bank to brokerages that then repackage the funds as investments in stocks or other financial products. The authorities are fighting to stem the tide as margin financing of share purchases has jumped fivefold over the past year to more than 2 trillion yuan. Not only has the securities regulator tightened rules on the practice, the People’s Bank of China has been channeling money away from the market that financial institutions use to borrow from one another.

Click here from WSJ.com

China's Siren Song Of Speculation

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