China Equity - A-Share Market Needs To See Liquidity Inflow Improve

What’s new — The domestic A-share market took a 6% tumble yesterday. From the recent high on 4th August, the market has declined more than 17% already. Yesterday’s trading volume was also about 40% below the recent peak trading days.

What's behind this — While there has been various speculation on a potential regulatory crackdown, we believe the fundamental reason behind the recent performance is that the A-share market is suffering from a significant slowdown in liquidity inflow, even periodical net outflow since the beginning of July.

Bank lending slowdown has a significant impact on stock market liquidity — According to our analysis, since the beginning of 2009, free-float growth in the domestic A-share market has a quite established relationship with monthly new bank lending. The monthly increases in free-float have been around 30% of monthly bank new lending.

The kick off of IPOs — Due to the suppressed market environment, IPOs were suspended for well over a year and only resumed in July 2009. The timing of IPOs coincided with the slowdown of liquidity inflow which further dampened market sentiment.

Sell down of previous non-tradable shares picked up significantly — We have witnessed a pick up in offloading of previous non-tradable shares that have come out of lock-up period. The volume in July was almost tripled that in January. Taking into consideration that the market almost doubled during this period, the value of the sell-down has probably grown 5-6 times.

Retirement of discounted bills — A meaningful percentage of new loans in 1H09, in particular in1Q09, were discounted bills, which are due to be retired. Typically these have 30 to 60 days maturity, and have been the mostly likely form of liquidity leaking into stock market. As we entered July, the retirement of such bills also placed a negative burden on the market liquidity.

August loan growth pick up could lead the market to a technical rebound, but a more sustained recovery needs to see a more substantial improvement in liquidity — As the market is close to the psychologically important 2,800 level, technical rebound is well expected. In particular, the government has reiterated its stand on continued support to a relatively loose monetary policy, which we believe should translate into some pick up in new lending in August vs. July. However, for the A-share market to resume sustainable upward momentum, we need to see meaningful sustained liquidity improvement from now on which should reverse the above negative factors.

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