Chinese Stock Market's Dizzying Fall Likely Not the End of the Bull Market

TAIPEI, Taiwan (TheStreet) -- A sharp drop in Chinese stocks this month is guardedly being viewed as a market correction fueled by regulatory problems and a flood of IPOs, rather than the start of a long fall.

The Shanghai Composite Index fell 13% last week and then another 4.8% early Tuesday before recovering. Although some analysts fear a bubble has seeped into the giant Asian economy's "A" shares, some market experts suspect a particularly strong market correction accentuated by the Chinese market's volatility.

Chinese shares have shot up over the past year largely on sudden interest by local retail investors who have been deterred by government policy from speculating on property investments. Shares rose 47% in 2014 and hit a seven-year high about a month ago. Stocks also posted modest gains Tuesday and Wednesday due in part to bargain hunting.

"It's seen as a correction, not the end of the bull market," said Andrew Tsai, economist with KGI Securities in Taipei. "In the second half of the year, from July, we will see shares go back into consolidation and slowly rise again."

The fall since June 15 followed a sell-off in shares by local investors to repay margin loans. Government officials moved in April to stop some of that margin lending and may strike again, raising fears of a new sell-off as restrictions affect more mom-and-pop investors.

A glut of IPOs in China, with 23 expected this month alone, has also diverted capital away from the broad market, another factor in its decline, some analysts say. The market would presumably gain liquidity once the IPO euphoria fades, however.

"New IPOs and margin lending rules overshot and pulled indices down a bit too much down last week, leading to a rather large sell-off by investors," said Denis Suslov, an analyst at research and consulting firm Kapronasia in Shanghai. "I expect the trend to reverse soon as the momentum was too high to disappear so quickly."

Foreign funds have also taken a keen interest in China's "A" shares. The market is officially off-limits to foreigners, but a growing number of institutions have won exceptions from the Chinese government to invest in the country's capital markets. Their number stands at 271 following three additions in May.

British bank Standard Chartered (SCBFF), for example, is overweight Chinese equities due to the odds of future policy easing, Hong Kong-based head of investment strategy Will Leung said Wednesday.

Foreign retail investors also can buy into China through exchange-traded funds such as FTSE China Bull 3X Shares (YINN) and iShares MSCI China ETF (MCHI).

A sustained return to growth in China doesn't mean the bull run lasts forever, though. The market is notoriously volatile, and the Beijing government can announce policy changes at any time to stoke more IPOs or reduce margin lending. They may also take steps to make the markets more accessible to foreigners through schemes such as the 2014 launch of the Shanghai-Hong Kong Stock Connect, but analysts see nothing new in the pipeline now.

"Expectations for policy accommodation had motivated the rally," said Tim Condon, Singapore-based Asia head of Research at ING Financial Markets, referring to rise in prices before June 15. "Without it, people are less interested. Now you've got regulatory risk that hasn't gone away and all these IPOs."

This article is commentary by an independent contributor. At the time of publication, the author held no position in the stocks mentioned.

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