Chinese stocks are set to see a further drop, despite a recent rout in equities, as government efforts to prop up its $5.1 trillion market have failed, according to world-renowned forecasters George Magnus and Tom DeMark.
Magnus and DeMark both believe that the benchmark Shanghai Composite Index could fall around another 20 percent from their current level of 3,160 to around the 2,500 level.
The Shanghai Composite has plunged nearly 40 percent and wiped out trillions of dollars since reaching a peak on June 12, when the market cap of Chinese stocks rose above $10 trillion for the first time ever, as mainland investors borrowed record amounts of funds to buy equities.
The largest ETF that tracks large cap Chinese Equities, the iShares FTSE China 25 Index, which has over $5 billion in market cap, has fallen over 30 percent since the June 12 peak.
Chinese stocks are nowhere close to bottoming out, according to George Magnus, a senior independent economic adviser to UBS, who accurately predicted in July that a rout would deepen in Chinese equities.
Magnus recently told Bloomberg that Chinese policymakers should stop intervening in the market and allow the Shanghai Composite Index fall to between a level of 2,500 and 2,800, which is in line with its long-run average.
In order to see any rally in equities from there, investors would need to see improving company profits and evidence that the government is committed to reform, Magnus said.
“When the equity market was falling in August, some people said this is a buying opportunity, that this is a multi-year bull market,” Magnus told Bloomberg.
“I don’t think we will see that unless there is a very significant change in the politics of China. We need to see significant change in the way in which the economy is working and in the way in which the reform is working and both of these things are on the rack at the moment,” Magnus said.
Tom DeMark, founder of DeMark Analytics, who also predicted the recent fall in Chinese stocks, has spent over 40 years developing indicators to identify market turning points.
DeMark recently told Bloomberg that the Shanghai Composite Index would likely fall close to 20 percent to a level of around 2,590 before prices bottom out.
Demark has advised hedge funds including George Soros’s Soros Fund Management and Leon Cooperman’s Omega Advisors, and has made several successful calls on the Chinese stock market in recent years. He has said his indicators work best to identify buy and sell signals in such markets where the governments can heavily influenced trading.
The rout in Chinese equities deepened in early August after China’s Central Bank moved to devalue its currency, which sent global stocks, currencies, and commodities tumbling and pushed emerging market stocks into a bear market.
As China continued to devalue its currency for three straight days, fears grew that other regional Central Banks would follow suit with their own currency devaluations, as such countries are attempting to maintain their own competitiveness against China.
— EMerging Equity (@EMequity) August 13, 2015
This was then confirmed as there would be devaluation events in Vietnam and Kazakhstan.
Following these devaluations, the rout in emerging market stocks and currencies intensified as oil prices were at a six-year low and continued to plunge amid a global glut, concerns grew about the U.S. Fed hiking interest rates, and as worries grew amid slowing growth in China.
There are also growing fears that we could be on the verge of the Asian Financial Crisis Redux.
Magnus recently wrote an opinion editorial in the Nikkei Asian Review: “Another Asia crisis is not inevitable — but don’t rule it out.”
As such fears grow, traders are not taking chances — as shown in the options market — and are positioning for further losses in Chinese stocks, as Bloomberg notes that bearish contracts on the mainland-listed China 50 ETF climbed last week to the most expensive level on record versus bullish ones, and in the U.S., an ETF designed to profit when Chinese shares fall has recorded a 60-fold surge in assets since June.
Even after a plunge in Chinese stocks, they are still overvalued and have further room to fall, as Bloomberg notes that equities on mainland Indexes traded at a median of 45 times their reported earnings last week, which is the highest among the 10 largest markets and more than double the 18 multiple for the S&P 500 Index.