China Traders Who Loved Leverage Left Reeling by Friday Rout

(Bloomberg) -- Margin traders who drove a clutch of stocks to the forefront of a dramatic upswing in Chinese equities now have a tough decision to make.

Friday’s 4 percent plunge in the CSI 300 Index was by far the steepest decline since the rally accelerated just over a month ago, and some of the bull run’s biggest winners were in the crosshairs. That’s a problem, because leveraged wagers on the 20 best-performing stocks in the gauge jumped by an average 89 percent from the start of February through March 5, according to exchange data compiled by Bloomberg. The average increase for the index as a whole was 25 percent.

Whether those indebted traders can tolerate such a painful daily loss may determine the future of a rally that’s been, by some measures, the most extreme since the 2015 bubble. Even with total margin debt in China still far below its peak from back then, JPMorgan Asset Management strategist Zhu Chaoping says pockets of the market have seen the kind of excessive optimism that history shows can end badly.

“Risks are already high for those stocks subject to speculation,” Zhu said in an interview, without naming any companies. “A large scale of margin trading is unregulated this time. This leads to a lower statistic number than in 2015, but higher risks. If the bubble bursts for some stocks, China might have to escalate regulatory action.”

On Friday, China’s stocks slumped the most since October after traders took a rare sell rating from the nation’s biggest brokerage as a sign that the government wants to slow down the recent rally. The Guangdong bureau of China’s securities regulator announced on the same day it would crack down on margin financing.

Financial data provider Hithink RoyalFlush Information Network Co. fell as much as 5.3 percent Monday before closing up 0.5 percent. Margin traders raised their holdings fourfold from early February through March 5 as the stock surged 90 percent, according to exchange data, which calculates leverage based on the net value that margin traders have borrowed from their brokers.

Wangsu Science & Technology Co Ltd., which also saw leverage wagers surged during the period, slumped 10 percent on Monday. Another hot target among margin traders, Anxin Trust Co. Ltd. dropped 3.1%, while the CSI 300 Index added 2 percent.

The “reckless” margin trading, which has quickly driven up the valuation of some stocks, risks a “deep correction,” Zhu said in a separate note before Friday’s sell-off. Leverage accounts for about 9 percent of free float of the top 20 stocks on the CSI 300 Index, according to data compiled by Bloomberg.

Name% Return (Feb.1-Mar.5)  Margin debt increase  Leverage as % of free float
Anxin Trust 94% 3%15%
Hithink RoyalFlush Information90%351% 9%
Kangmei Pharmaceutical74% 14% 5%
Wangsu Science & Technology70%50% 12%
BOE Technology Group69%57% 10%
New Hope Liuhe 62%61% 7%
East Money Information60% 89% 10%

©2019 Bloomberg L.P.