China’s focus on bubble risks is a warning sign for the stock market

(Bloomberg) – For investors worried about an end to the era of cheap and plentiful debt, China gave just one more reason to worry.

The nation’s leading bank regulator shook markets on Tuesday with a warning about the need to reduce leverage amid the growing risk of bubbles globally and in the local real estate sector. The effect on Chinese equities was rapid: the CSI 300 index fell as much as 2.1% to lead declines in Asia, while Kweichow Moutai Co., the largest contributor to gains during the 2020 stimulus cycle, tumbled almost 5%. China’s largest share has lost more than $ 100 billion in nine days.

Central banks around the world face the challenge of when and how to drain stimulus as economies recover from the pandemic. Global bond markets crashed last week when traders pulled out investments in interest rate hikes, with the 10-year government interest rate reaching a maximum of one year.

Deleveraging has a special resonance in China, where it is an important priority for President Xi Jinping due to the size of the country’s mountain of debt. A counterbalance to the leverage effect in 2017 sent the yield on corporate and government bonds to multi-year highs before officials stopped the unit a year later in the middle of the deteriorating trade war with the United States.

Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission and party secretary to the central bank, did not mock his words. “From a banking and insurance industry perspective, the first step is to reduce the high leverage in the financial system,” Guo said at a briefing in Beijing. Speculation in the real estate market is “very dangerous” and bubbles in US and European financial markets could soon burst, he said.

“His speech shows a willingness to tolerate higher interest rates,” said Zhiwei Zhang, chief economist at Pinpoint Asset Management in Hong Kong. “This is a confirmation that the monetary tightening is strengthening. It is important.”

A stronger economy and signs of exaggeration have provoked stronger rhetoric from Beijing in recent weeks. The People’s Bank of China said in its latest monetary policy report that it will balance the need to support growth and prevent risks. A front-page report in state media last week claimed that the economy is strong enough to withstand political normalization. In January, the central bank constructed the largest cash press since 2015, after an adviser proposed a transition from stimulus.

The debt was about 280% of China’s gross domestic product in November, the highest ratio since Bloomberg began compiling data in 2014.

Beijing will unveil key economic targets on March 5, when the National People’s Congress, China’s rubber stamp parliament, convenes for its annual meeting. While officials have stressed that policy changes would take place gradually, China’s monetary policy conditions will “appear to be tightening this year,” Li-Gang Liu, chief executive officer and chief economist of Citigroup Inc., wrote in a report this week.

The prospect that China will tighten financing conditions tracks the gains in the country’s most popular stocks. Wineries like Moutai are hardest hit because they are largely owned and have some of the highest values. The CSI 300 index – which briefly topped its record close to 2007 in February – has lost 7.9% since the mainland markets opened for the new lunar year.

The authorities are juggling to limit the leverage while maintaining economic growth ahead of the Communist Party’s 100th anniversary this year. The central bank has successfully calmed the interbank financing markets since January, when short-term interest rates rose to the highest since 2015.

“Reduction and financial risk reduction will both be in focus in 2021,” said Tianhe Ji, a strategist at BNP Paribas SA in Beijing.

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