After a burst of volatility in the developed market over the past month, one odd outlier was China, where after a surge of gut-wrenching moves in both its currency and equity markets (recall that it was China's troubles with marketwide circuit breakers at the start of January that may have catalyzed the global volatility wave), Chinese stocks remained relatively quiet and resilient, levitating quietly day after day. That all changed overnight when the Shanghai Composite plunged by 6.4% with the drop accelerating into the close. This was the biggest drop in over a month and was big enough to almost wipe out the entire 10% rebound from the January lows in one session.
There was confusion about what catalyzed the selling with several theories proposed.
According to one, the catalyst was a jump in money market rates: the overnight repo rate jumped as much as 33 bps which led to a tightening in financial conditions. The cash squeeze was caused by banks' reserve submission and corp. tax payments for 2015 due this week: Commerzbank economist Zhou Hao
"Market confidence is very weak so an increase in money-market rates triggered a sell-off today," said Wu Kan, a fund manager at JK Life Insurance Co. in Shanghai. "Technically speaking, the rebound has reached its target and a new round of declines is resuming. The valuations of smaller companies are still too high and that's the basic reason behind the plunge. I am not too sure that the government will step in to buy stocks now." Judging by the final result, he was right.
A second theory speculated that losses accelerated after regulators banned Zhongrong Life from adding to its equity investments, according to Castor Pang, head of research at Core-Pacific Yamaichi Hong Kong. "Zhongrong Life can't add to holdings as its solvency ratios fall into criteria of insolvent insurers", China's Insurance Regulatory Commission said.
This is a problem because "the government is trying to make sure all insurance companies need to meet potential demand for claims from clients and keep liquidity ample," says Pang. "But almost all insurers which heavily bought shares last year when the Shanghai Composite was at high levels" are facing problems. As a result, the latest black swan to appears in China in the form of Zhongrong Life's situation, is fueling concern further selling pressure in stock market: Pang
"A big jump in Shanghai turnover implies investors turned risk averse and want to dump holdings en masse," Pang says. "Investors are scared of further declines. The government may try to step in to calm investors' nerves. It may help moderate losses but can't reverse the trend."