Talk about irrational exuberance. Despite slowing growth, Chinese stocks have doubled in a year and retail investors continue to pour in, with more than three million brokerage accounts opening per week. What’s more, “there’s a huge amount of leverage built in”, as Macquarie’s Michael Smith notes.
Many investors are speculating on equities with borrowed money: margin debt has tripled in the past year, and now accounts for over 8.2% of the free float – the value of stock that is freely traded and thus accessible to ordinary investors.
China’s free float is far smaller than elsewhere as the state accounts for half the market. In the US, margin debt is worth 2.5% of available stock, notes Chao Deng in The Wall Street Journal. High margin debt makes the rally more vulnerable to shocks. Investors hit by losses may be forced to sell stocks to cover demands for more capital from their brokers, exaggerating any downswing.