China’s $1.5 Trillion Stock Bubble is Dangerously Overheated

• China’s Nasdaq-like ChiNext Index dropped by 3.3% as the local stock market started to sell-off.
• With a small stimulus package compared to the U.S. and Europe, Chinese stocks face a pullback.
• State-owned funds have also started to trim their holdings in equities.

China’s ChiNext Index plunged by 3.3% on a single day, kickstarting a downtrend in China’s stock market. Top fund managers expect Chinese stocks to cool down after an explosive two weeks.

The ChiNext Index is a Nasdaq-like index of stocks on the Shenzhen Stock Exchange. The index is primarily composed of fast-growing high-tech companies.

China’s Stock Market Expected to Sell-Off as Global Markets Pull Back

From July 7 to 13, the stock market of China saw a steep uptrend due to two main factors.

First, the Chinese state media led to enthusiasm towards the stock market in early July. It described the trend of local equities as a “healthy bull market.”

Mark Williams, the chief Asia economist at Capital Economics, told CNBC that China had used a similar strategy before. He emphasized that in 2015, the state media released similar statements about the stock market.

He said:

There’s quite a long history of policy makers using the media to drive up the market. It doesn’t always end very well. We saw that back in 2015, exactly the same statements then.

Second, China’s economy has beaten the expectations of economists everywhere.

As the Chinese yuan strengthened to levels unseen since March and exports grew, the sentiment around the economy rose.

While two clear catalysts boosted a strong stock market boom in China, top financiers are becoming cautious.

Dai Ming, Hengsheng Asset Management’s fund manager, said that China wants its stock market to cool down.

The central bank and local financial authorities are possibly concerned about stocks overheating to unsustainable levels.

Ming noted:

The recent wave of stake reductions by big funds is a signal that China wants the market to cool down a bit. [Policy makers want] to see a slow bull market that matches the pace of the economic recovery.

State Funds Are Leading the Downtrend

After optimistic state media reports catalyzed a stocks rally, government-owned China Economic Times warned investors of a “crazy” bull market.

The local report followed the move of two government-operated funds to sell-off stocks on July 10. 

Caixin reported that local regulators asked mutual funds to restrict new products, in an attempt to calm the stock market.

The recent initiatives of the Chinese government indicate that it foresaw an equities bubble forming, and is placing preventive measures.

While the U.S. and Europe aggressively implemented multi-trillion dollar stimulus packages, China revealed a $500 billion fiscal stimulus proposal. 

China is seemingly preparing for long-term financial and economic stability over short-term relief. For investors, that might mean slow and gradual recovery in the stock market in 2020.

But, some strategists said in May that China tends to introduce stimulus incrementally. 

Macquarie’s chief China economist Larry Hu said:

The incremental amount [of fiscal stimulus] is small. Traditionally, China’s stimulus is not released at one go, but step by step. A bigger stimulus will only be seen when numbers are bad enough.

Due to the unpredictability of the pandemic and its potential economic consequences, China is swaying towards a cautious