Four reasons behind China's A-share volatility

Mainland China's stockmarket recovered somewhat on Friday following a week of severe volatility. So, what were the main reasons behind the week's market falls?

8 January 2016

Schroders Investment Communications Team

Continued yuan weakness

Widely cited as the key driver of the week's sell-off, the currency was weaker on Wednesday after the People's Bank of China (PBoC) unexpectedly fixed the midpoint rate at 6.5314 per US dollar prior to the market open, even weaker than the previous day's closing quote of 6.5157.

This triggered further selling in the offshore yuan, which slumped to 6.7250 per dollar on Thursday, its lowest since trading began in 2010 and a record discount of about 2.5% to the onshore rate of 6.5526.

This added to a spread that is encouraging capital to flow out of the country.

On Friday the yuan gained, rising to 6.5885 in onshore trading. Offshore yuan also climbed - to 6.6799 against the dollar.

Expiration of selling restrictions

CSRC, China’s state market regulator, had imposed a restriction on major shareholders selling their holdings following last August’s steep falls.

The expiration of this ban, due on the 8th January 2016, could have been a key trigger for the latest sell-off as investors dumped shares ahead of the expiration.

It is estimated that RMB 100 billion worth of shares will be available for sale if the expiration is allowed to take place.

Following Thursday’s fall, the CSRC also capped, at 1%, the size of stakes that large investors are allowed to sell, for three months effective the 9th January.

This cap will replace the existing six-month ban on any secondary market stock sales that was due to expire on Friday.

Economic fundamentals remain sluggish

A private survey that was released earlier this week showed China’s factory activity had contracted for a tenth consecutive month in December, and at a faster pace of decline than November.

Last Friday, official manufacturing data, which focus on larger state-owned firms, revealed a fifth consecutive month of contraction.

However, a pick-up in the services sector may cushion the negative impact on the broader economy.

Reinforcement effect

The correction apparently set off even more intensified selling and the triggering of the circuit breaker appeared to have heighten panic in the markets as liquidity dried up.

The Chinese securities regulator since announced a suspension of the new mechanism, saying the system did not work as anticipated and instead was exacerbating stock losses.

Investment implications

Given that we take a long-term view on our Asian equity investments, and we are cognisant that this is a volatile asset class, the recent fall does not have an immediate impact on our investment views of the stocks we hold.

In addition, it might also create buying opportunities to accumulate certain stocks on weakness.

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