Analysts have grown increasingly concerned about the mainland stock market bubble with Credit Suisse saying that it expected mainland small and medium-sized caps will crash 50 percent when the bubble bursts.

Meanwhile, the benchmark Shanghai Composite Index tumbled 3.7 percent to close at 4,785.4 on Thursday. Stock analysts attributed the slide to the large number of initial public offerings that have drained sizeable amounts of liquidity from the market.

So far this week, the benchmark indicator has dived a total of 7.4 percent, heading for the steepest weekly loss since February 2009.

It's a question of when the bubble will burst, said Vincent Chan, Hong Kong-based head of equity research at Credit Suisse Group AG, Switzerland's second-biggest bank. He said he was particularly concerned about the stocks of the many small and medium-sized companies which have raised too much capital in the latest rally. The valuation of these highly geared enterprises has reached critical level, he added.

The ChiNext Index of small cap companies sank 6.3 percent to 3,504 on Thursday, paring its gain this year to 138 percent.

Chan said that he was less worried about the blue chips on the mainland market, because of their limited downside risk. Nevertheless, he predicted that the prices of blue chip stocks will fall by an average of no more than 10 percent in coming months.

Shares of the highly leveraged enterprises, big or small, have become vulnerable to a market correction which is certain to happen in the near future, Chan said. A major adjustment can be triggered by a clamp down on rampant margin trading which amounted to a record 1.7 trillion yuan ($274.6 billion), with hedge funds and corporate investors being the main players.

Chan voiced his concerns over the mad rush for the so-called "concept" stocks by the arms of retail investors. Such buying had pushed up the prices of those stocks to levels that could not be justified by market fundamentals. For that reason, they will fall the hardest when the bubble bursts, Chan said.

The average valuation of Hong Kong-listed stocks is more realistic than that for mainland stocks, Chan said. But the Hong Kong equity market could be hit by a sharp decline on the mainland because of the big increase in investment from the mainland in recent months.

The Hang Seng Index fell 0.2 percent to close at 26,694.6 on Thursday. Chan said that he expected the central government will provide policy support to avoid an outright crash.

"I am not surprised to see the required reserve ratio being reduced to 9 percent from current 18 percent in the coming two years," Chan said. "The mainland's central bank is also widely expected to cut interest rate by 25 basis points in the third quarter," he said.

Credit Suisse predicted further weakening of the exchange rate of the renminbi by up to 5 percent against the US dollar in 2016.

celia@chinadailyhk.com

(HK Edition 06/19/2015 page9)