AFTER the longest-ever rally in Chinese equities, investors are getting a reminder that the US$7.3 trillion market isn’t just a one-way bet.

    China’s securities regulator jolted traders after the close of the stock market Friday when it banned a source of financing for margin trades and made it easier for short sellers to wager that stocks will fall. The Shanghai Composite Index fell 1.6 percent yesterday, following a tumble in offshore futures and exchange-traded funds linked to the world’s second-largest stock market.

    While China bulls drew some comfort from the central bank’s biggest cut to lenders’ reserve requirements since 2008 Sunday, the selloff shows how vulnerable the Shanghai Composite is to a pullback after going 455 calendar days without a 10 percent drop from a recent high. The benchmark gauge posted an average peak-to-trough retreat of 28 percent after six previous rounds of policy intervention to curtail stock speculation since 1996, according to Bank of America Corp.

    “Institutional investors as well as authorities have had some concerns over the sharp rise in prices and trading,” said Michael Kass, a New York-based money manager at Baron Capital Inc., whose US$1.53 billion emerging-markets fund has outperformed 95 percent of peers over the past three years. “This will likely cool some of the recent enthusiasm.”

    The Shanghai Composite’s 115 percent surge from last year’s low Jan. 20 is challenging authorities as they seek to weigh the benefits of rising share prices against the risk that individual investors will get burned by excessive speculation.

    Traders in Shanghai have borrowed a record 1.2 trillion yuan (US$194 billion) to buy equities via margin trades, while new investors have opened an unprecedented number of stock accounts this year. The Shanghai Composite trades at 16.5 times estimated earnings for the next 12 months, the highest valuation in five years, even after data last week showed economic growth slowed to the weakest pace since 2009 in the first quarter.

    On Friday, the China Securities Regulatory Commission (CSRC) prohibited the margin-trading businesses of brokerages from using so-called umbrella trusts, which allow investors to take on more leverage. Authorities also allowed fund managers to lend shares for short sales, a move that will make it easier to execute bearish bets, and expanded the number of stocks available for this kind of trading.

    The announcements came a day after CSRC Chairman Xiao Gang said in a speech on the regulator’s website that investors should “fully evaluate risk in stock market investment” and be cautious.

    “The regulator is trying to reduce leverage,” said Lu Wenjie, a Shanghai-based analyst at UBS Group AG. “There could be a pullback in the market.”

    Chinese authorities last targeted margin trading Jan. 16, when they suspended three of the nation’s biggest brokerages from adding new margin accounts after they let customers delay repaying financing. The Shanghai Composite Index sank 7.7 percent the next trading day, its steepest drop since June 2008.

    In a previous campaign to cool markets between April and June 2007, regulators and domestic media repeatedly warned that the stock market was overheating. The benchmark continued to rally to a peak in October before collapsing. By November 2008, the index had crashed 72 percent as the global financial crisis spread.

    Announcements over the weekend from Chinese policymakers helped counter the impact of moves to rein in speculative trading.

    The nation’s reserve requirement ratio would be lowered 1 percentage point effective April 20, the People’s Bank of China said on its website Sunday, the second reduction this year and the largest since November 2008. (SD-Agencies)