China's Stock Market Shocks the World by Going Nowhere Fast

 | Apr 20, 2017 | 10:00 AM EDT
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China's stock markets are so famously volatile that it's not unusual for the entire stock market to double, halve, then double again. This happened in 2007 (up 190%), 2008 (down 70%) and 2009 (up 107%).

The market is driven by flighty retail punters who look for any whisper of insider insight, go with any sign of momentum, or even play lucky numbers. Government intervention is so heavy and sudden that buying Chinese stocks is akin to buying an option elsewhere in the world. 

The minimum intra-year range of volatility since the Western financial crisis began in 2007 has been 28%, and often a lot more. Last year, the benchmark CSI 300 index of China's largest stocks, including listings from both the big-cap market in Shanghai and the tech-driven bourse in Shenzhen, rose by one third as fears of an economic hard landing subsided. The year before, stocks surged in the middle of the year, then crashed -- up 52% one moment, down 40% the next. Phew!

What are we to make of 2017 then? Stocks have gained a shocking ... err, 1.9%. The Shanghai Composite Index, another well-watched index, has gone 85 days without a change of more than 1% by the end of the day. 

That's the longest streak, Bloomberg notes, since the market's infancy in 1992. There have been only 13 days this year when the index ever moved more than 1%, only to return within the trading band by the end of business. On Wednesday, the market at one point showed a 1.6% loss, but rallied in the last 90 minutes to close down about half that amount. Chinese stocks gained 0.5% on Thursday, meaning that over the two days, they were flat.

I asked a trader buddy of mine once what he thought was the hardest trade to construct and play. A "butterfly spread," he figured -- a delicate position of options contracts designed to pay off when the market goes nowhere. Now appears to be the perfect time to put one in place.

It is likely that China's stock watchdog, the China Securities Regulatory Commission, has been trying to stabilize the stock market and stem the extent of declines in particular, Bloomberg reports, citing unnamed sources "familiar with the strategy."

That presents an arbitrage play for anyone fast enough to move in and out of the market as soon as it dips below 1%. Beware, however, that unusual patterns of play, such as a recent spell of early-afternoon declines concluded by closing rallies, have never lasted too long in the past.

The Communist Party is terrified of social instability. It's trying to shut down the dodgy "shadow banking" industry of high-yielding trusts, held off banks' books and often containing subprime or unknown risks. So the stock and property markets are the only venues for investing domestically. 

It has finally got a handle on the runaway real-estate prices in China's "Tier 1" cities: Beijing, Shanghai, Guangzhou and Shenzhen. There are cooling measures in place in many of the "hottest" cities. So the speculators are shifting to stocks.

But what begins as a rally driven by full-time speculators inevitably catches up "mom and pop" investors, leaving them standing when the game of musical chairs ends. Beijing wants to prevent the music from starting, if at all possible.

The CSRC recently warned that it will punish people found guilty of manipulating newly listed stocks, as I explained on Tuesday. There were rapid runups in many of those stocks, followed by the maximum permissible daily decline, of 10%, after the regulator opened its mouth.

Government meddling does drive the Chinese economy, and by extension the stock market, even if retail investors grab the steering wheel once the vehicle gets going. That's why Chinese stocks give "shareholders" not much more ownership of a company, particularly a state-owned one, than an option.

China Mobile (CHL) , China Unicom (CHU) and China Telecom (CHA) own the three mobile-phone licenses in the country now. But we could wake up to find that the regulator has overnight doubled that number, without any of the public consultation that would take place in the West.

You may own part of a business and be able to value it today, in other words, but who on earth knows about tomorrow?

It may also be that the fallow period in Chinese stocks is simply driven by the stable growth demonstrated across most of the globe. The International Monetary Fund reflected this on Tuesday, boosting its forecast for Chinese economic growth in 2017 by ten basis points to 6.6%.

The figures for the first three months of the year already came in better than expected, thanks to a surge in services and consumption, as I outlined on Monday. March was particularly good, suggesting even the slowing China that the government itself expects is not yet manifesting itself.

Global growth, the IMF predicts, will run at 3.5% in 2017, up from 3.1% last year. That was also 10 basis points better than the previous forecast.

The Communist Party is prepping for the crucial 19th National Congress this fall. That meeting will decide the path for the next five years. It will also settle the membership of the Politburo Standing Committee, which includes President Xi Jinping and his top cabinet members, the leaders of the nation.

Xi is now attempting to solidify his hold on power, which already makes him the strongest Chinese leader since Chairman Mao. Instability in the run-up to the congress isn't welcome, and won't be tolerated.

There's time to put that butterfly spread into flight still.

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