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China stock swoon could signal end of bull run

China stock swoon could signal end of bull run

Just two weeks after hitting a new high and sporting a 60% year-to-date gain, mainland China’s Shanghai composite index is down nearly 19% and flirting with a bear market. The steep, dramatic drop is raising questions as to whether the bull market China — which has been the envy of the world the past 12 months with gains in excess of 150% — is a bubble in the process of bursting.635572339866434100-AP-China-Financial-Markets

The wild volatility in mainland China shares, which has been fueled by government stimulus, everyday Chinese folks buying into the stock frenzy with borrowed money to goose returns, and fears of overvaluation, continued Friday. The Shanghai composite plunged 7.4%, extending its losses since its June 12 high of 5166.35 to 18.8%.  Despite the selloff, which pushed the index back to levels last seen in early May, the Shanghai composite is still up a healthy 29.6% for the year. The bull market is now 935 days old.

China’s Shenzhen composite index, a smaller stock gauge often compared to the tech-packed Nasdaq composite in the U.S., did officially enter bear market territory today. It’s down 20.3% from its high. A bear market is defined as a drop of 20% or more. “China is collapsing,” Paul Hickey of Bespoke Investment Group noted this morning in a client note. Investors are blaming the selloff on a number of factors, ranging from angst over the Greece debt talks to signs that Chinese investors that have been using borrowed money to buy shares are reducing the amount of debt they have piled up to buy shares. Outstanding margin debt on the Shanghai Stock Exchange dropped for a fourth day on Thursday to 1.42 trillion yuan ($229 billion), according to Bloomberg, the latest sign that investor speculation is cooling.

Paring down so-called margin debt involves reducing stock positions, which drives down prices. Many investors in China are also getting squeamish with the market after its straight-up run over the past year, and fear that the gains are not sustainable. “China’s stock rally has defied economic reason, and we don’t think there’s any reason the selloff should either,” Bespoke’s Hickey says, noting that onshore A-shares “are in many cases hideously over-valued.”

Bespoke notes that margin debt is now 4% of the Chinese stock market’s value and has “exploded higher” as A-shares have skyrocketed. The Chinese stock market has been levitating with the help of stimulus policies from the nation’s central bank and central government. Investors, however, are wary of authorities cracking down on excess margin debt and uncertainty as to whether policymakers will once again announce fresh stimulus measures to prop up the slowing economy.