China's stock market is experiencing a surge in trading activity, reaching record highs, and regulators are growing concerned. The Shanghai, Shenzhen, and Beijing stock exchanges saw daily turnover climb to unprecedented levels last week, with trading volume peaking at 3.99 trillion yuan ($556 billion) on Wednesday, surpassing the previous record set in October 2024. This surge has sparked fears of a market bubble, reminiscent of the 2015 boom-and-bust cycle.
Market veterans warn that the current rally may be in its early stages, but regulators are taking action to curb leverage. China's stock market is dominated by retail investors, who account for about 90% of daily turnover, contrasting with major overseas markets where institutions dominate. This high level of retail participation makes the market more volatile and susceptible to sudden shifts in sentiment.
Regulators have responded by tightening margin financing rules, including raising collateral requirements on new margin trades. Under the updated rules, the margin requirement for credit purchases was lifted to 100% from 80%, effectively eliminating borrowing on new margin trades. This suggests an 'overheating' of activity and sentiment in onshore markets, according to Morgan Stanley.
The investment bank's A-share Market Sentiment Activity Index surged to 91%, the first reading above the 90% threshold since September 2024, driven by the spike in trading volumes. However, analysts expect added liquidity support to persist through the first quarter.
Foreign investors have also stepped up their activity, with net inflows exceeding $50 billion in recent months. Despite this, foreign participation remains small relative to the overall size and turnover of the A-share market. Domestic investors continue to drive the rally, according to Theodore Shou, chief investment officer at Skybound Capital.
The dominance of onshore capital has led regulators to take a cautious approach to leverage. In China's equity market, leverage primarily comes from margin financing, which amplifies gains and losses. When leverage builds, rallies can accelerate but are also more vulnerable to abrupt reversals if sentiment shifts. Regulators aim to engineer a 'slow bull' market by tweaking leverage, rather than signaling concern about systemic risk.
Market veterans suggest that the latest margin-financing adjustments are calibrated to temper speculative excess and promote a 'slow bull' market, concentrated in specific sectors like AI-related and technology stocks. The ChiNext board has surged nearly 50% over the past six months, outpacing the more modest gains in the Shanghai Composite Index, indicating that enthusiasm remains selective.
