China Stocks

The mainland Chinese stock market, which had gained more than 150% in a year’s time, prompting bubble warnings, seems to be deflating, as shares dipped 13.3% this week.

The Shanghai composite index had its roughest week since the financial crisis back in 2008, putting it in official correction territory for the second time this year. A correction is defined as a decline of 10% or more from a recent high.

The China index, popular with newbie investors in China, many who are buying stocks with borrowed money to amp up returns, tumbled 306.99 points, or 6.4%, to 4478.36.

“The most notable move in Asian markets today,” Barclays told clients in a research note, “has been the large correction in Chinese stocks.”

The selloff follows a heady run for Chinese stocks. The Shanghai index soared nearly 158% from its intraday low of 2010.53 on June 20, 2014, to its intra-session high of 5178.19 last Friday.

“The incredible rally in mainland-traded stocks has led to many headlines about a stock market bubble in China,” Jeff Kleintop, chief global investment strategist at Charles Schwab, said in a client note.

What caused the selloff this week? Growing fears that a market bubble may be deflating, experts say.

“Concerns that equities are over-valued” is the way Barclays summed things up, adding that investors fear Chinese stock regulators might crack down on the use of borrowed money, or margin debt, to fund stock purchases.

Margin debt in China has soared to a record $363 billion, according to Bloomberg, and the median stock in mainland China is now trading at 95 times earnings, which even tops the price-to-earnings multiple of 68 back at the 2007 peak.

Still, the big selloff in China A-shares is unlikely to spill over to global markets, analysts at Bespoke Investment Group.

Here’s why:

* Chinese market is not economy

“If there was ever a poster child for ‘the stock market is not the economy’, it would be onshore equities in China over the last six months,” says Bespoke.

* Chinese stock market is a “local” phenomenon

“The beginning, middle and end of this story is that Chinese shares soared thanks to a local factors that had no impact on foreign markets, and the factors which send them down will be identical in their disconnection to foreign markets,” Bespoke argues.

* Long-term uptrend still intact

The Shanghai composite breached its average price over the past 50 days, but the longer-term trend is its average price over 200 days.

“We don’t have a prediction for how long this correction in A-shares will last, but we would say that even if it gets truly bad, there are very few mechanisms that would allow it to spill overseas; this is more true of China’s market than almost any other in the world.”

Bespoke points out that other Asian markets fared better on Friday, with shares in Hang Seng rising 0.3% and stocks in Tokyo rising 0.9%.

Kleintop advises clients to focus on less-speculative Hong Kong shares for their China exposure.