Global Rout Threatens to End China’s Leverage-Loving Stock Binge

The recent buoyancy in the world’s second-largest stock market in China will be under threat Monday after oil plunged and U.S. index futures tumbled.

A gauge of stocks in Shanghai and Shenzhen touched a two-year high last week, rebounding as much as 14% from its coronavirus low, as speculators took advantage of easier liquidity conditions to bet on sweeping government stimulus. Such optimism was a glaring contrast to the gloom enveloping global markets: the CSI 300 Index beat the MSCI Inc. measure of global shares by more than 4.5 percentage points for a third week, unheard of since 2014.

With China’s $1.2 trillion stock rally fueled mostly by hope andleverage, the risk for Communist Party officials now is that fear becomes the dominant emotion, sending markets spiraling down. That would undermine efforts to ensure financial stability as authorities try to restart aneconomy that’s been mostly shuttered for more than a month. Futures on the FTSE China A50 Index dropped 3.6% as trading opened Monday in Singapore.

Data over the weekend showed the impact of the virus on China’s trade with the rest of the world. The drop in exports was a bigger-than-expected 17.2% in dollar terms, while imports declined 4%, according to astatement from Chinese customs Saturday.

“Pundits believe that Chinese stocks, especially the ChiNext at extremely overbought levels, can offer risk shelter for the extremely oversold global stocks,” Hao Hong, chief strategist of Bocom International Holdings Co., wrote in an email Monday. “It is a reckless call. The Chinese stock market is diverging from fundamentals. And a ChiNextbubble is looming.”

Low valuations may support Chinese equities. The Shanghai Composite trades at less than 11 times its members’ projected earnings, versus a peak of 19 times in 2015. In the U.S., the S&P 500 Index currently trades at about 17 times profit. The government can also count on largely state-owned brokerages and insurers to limit selling, while the largely closed off nature of China’s markets makes it more immune to swings in other markets.

For more on Monday’s markets:
Oil Drops 31% in Worst Loss Since Gulf War as Price Fight Erupts
Deepening Rout in U.S. Stock Futures Triggers Limit Down Rules
Crazy Start to Currency Trading Gives Hint of Markets in Crisis
Everything China Is Doing to Support Its Markets During Outbreak

There was little sign of concern toward China in the currency market on Monday morning, with the offshore yuan strengthening 0.1% against the dollar in its 11th day of gains out of the past 12.

Yet it would take a particularly blinkered trader to ignore the crashing sound of global markets. Crude sank as much as 31% on Monday, the most since the Gulf War in 1991, while an almost 5% tumble in S&P 500 futures triggered trading limits that prevent further declines. Japan’s yen, seen as a haven, surged to its highest level since 2016.

The dominance of China’s army of 160 million retail traders in the equity market makes it especially exposed to such changes in sentiment. Beijing will be hoping its citizens hold their nerve.

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