Chinese Stocks Rise After Monday's 7% Fall, Analysts Say New Circuit Breaker May Have Added To Panic

SHANGHAI — Chinese shares closed mixed in volatile trading Tuesday, following Monday’s 7 percent fall that led to trading being suspended under the Chinese market’s new circuit-breaker mechanism. The falls on Monday triggered drops in markets in the U.S. and Europe but, after briefly plunging again in early afternoon trading on Tuesday, the main Shanghai Composite Index recovered to finish the day just 0.26 percent lower. The secondary Shenzhen Composite Index closed some 1.8 percent down, while the CSI 300 Index of leading Chinese stocks rose 0.28 percent.

Analysts said government-banked investment funds had intervened in the market on Tuesday in an attempt to stem the slide in share prices. In Hong Kong, meanwhile, the Hang Seng Index, which also fell by more than 2 percent on Monday, was down some 0.5 percent in mid-afternoon trading, on continuing anxieties about the Chinese economy.

Monday’s falls were not unprecedented on China’s notoriously volatile market — the new circuit-breaker mechanism, which came into operation Monday, was introduced following a dramatic boom and bust in 2015, when the market doubled in value in six months before losing 30 percent from June to July. It also fell some 8.5 percent in a day in late August.

But analysts said Monday’s falls were caused by the coalescing of a range of factors, not all of them related to the fundamentals of China’s economy, while some blamed the circuit breaker for making the situation worse.

One undoubted cause of negative sentiment was the release of data from China’s manufacturing sector, which slowed faster than expected last month amid falling export demand, according to the latest Caixin Purchasing Manager’s Index. But many Chinese analysts said a bigger factor was worries about the ending of a six-month moratorium on the sales of stocks by major shareholders in listed companies. The ban on sales by the holders of more than 5 percent stakes in companies was introduced last summer to help stem the market collapse, but is due to end this Friday.

“The market was dragged down by worries that major shareholders will sell shares as soon as the ban is lifted,” said Guo Feng of Northeast Securities, the Shanghai Daily reported. The China Economic Times, meanwhile, said there were fears that the resumption of trading in the shares, estimated to be worth 1.1 trillion yuan (around $169 billion), would drain investment from other shares.

And the continuing decline of the Chinese yuan against the dollar is also seen as encouraging Chinese investors to take money out of Chinese stocks at present. The U.S. Federal Reserve’s decision to raise interest rates last month for the first time in nine years is seen to have added to downward pressure on the yuan, which the government devalued by some 3 percent last summer. On Monday China's central bank cut the reference rate for the yuan by some 0.3 percent, leaving the yuan at 6.5172 against the dollar, its lowest rate in almost five years.

“Capital has been flowing out of China’s stock market for nine straight weeks,” Shanghai brokerage Shenwan Hongyuan said in a research note, adding that this would likely “continue for a while… as the US enters an interest hike circle and China’s economic growth remains weak.”

China has suspended foreign exchange business at several foreign banks in an attempt to stem capital outflows, Chinese media reported Monday, without naming the banks involved.

Shanghai-based market commentator Xi Feng told International Business Times that capital outflows were inevitable as the dollar strengthened, but he said some of the sales were also profit-taking ahead of the resumption of sales in blocked shares Friday. The Shanghai market, which fell below the 3,000 mark last autumn, had rebounded to finish the year at just over 3,500 — still up some 15 percent on the year — and opinion remains divided about whether it is still overvalued.

And Xi also said the circuit breaker had amplified the fall. “In the past if shares fell 6 or 7 percent, a lot of people would see an opportunity to buy them up on the cheap,” he said, “but now the circuit breaker prevents that happening. And to retail investors without much experience of the market it sounds scary, and could also add to their sense of panic.”

Analysts pointed to the fact that after a 15-minute suspension of trading when the market fell 5 percent after lunch Monday, there was a further rapid sell-off that led to its closure for the day a few minutes later, after dropping 7 percent. Some observers have also suggested that linking the circuit breaker to just the China Stock Index of 300 of the country’s biggest shares, rather than all China's listed companies, makes the new system more vulnerable to manipulation.

Critics noted that the U.S. has only used its own circuit breaker once in some three decades, while China’s was used on the first day — with some experts warning that the 5 percent cut-off point was too low given the volatility of China’s markets, which observers say are often driven by sentiment as much as economic fundamentals, due to the presence of tens of millions of relatively inexperienced retail investors.

China’s stock market regulator, which introduced the circuit breaker, said Tuesday that the mechanism would help protect investors’ interests. However, it said that it would take time to adapt to the new system, and it was studying ways of improving the rules for its use, financial magazine Caixin reported.

However some economists said pressure on the Chinese stock market was inevitable in the coming months, as the government was likely to gradually reduce its level of intervention in the market. Government-backed funds poured tens of billions of dollars into the market last summer in an attempt to prevent it falling further. But some analysts have criticized the regulator for intervening too early, and propping up share prices at an unsustainable level.