A downward correction in China's stock market is considered inevitable and necessary, given high PE ratios for China's listed companies and rampant irregularities in China's securities industry. But the latest correction is triggered by a number of factors related to both the government's reform efforts and the cyclic adjustments.

First, and the most hurting, is the government's new crackdown campaign on illegal bank financing of stock market investments. A comprehensive examination of the banking funds into stock market has been carried out, with the branches of several large banks in Shenyang being punished. This has resulted in both a physical withdrawing of funds from the stock market and a psychological impact on investors' perception of demand prospect of the stock market.

Second, while being equally hurting, is the start of the sell-off of the state shares in listed companies. The fact that 10% of the shares issued by 4 listed companies late July are state shares sends a message to investors that a large scale sell-off of state shares is pending. Also the prices of the state shares, which turn out to be as same as those of other shares, is higher than widely expected and hence disappointing. This has inevitably exerted a great pressure on the stock market from supply perspective.

Third, over 100 listed companies have announced the plan to issue additional shares, including the Shanghai Pudong Development Bank that has come up with a plan to issue RMB300 mn of additional A-shares. This has increased investors' worries about over-expansion of stock market volume while causing new concerns about the justification of listed companies raising funds.

Fourth, 100 listed companies have issued a warning on loss and 67 issued warning on profit for interim results. Though these numbers are less than those for last year's interim results, many hi-tech companies have really suffered a deterioration of profit performance, following the global trend.

Fifth, though China's economy continues to outperform others', global economic slowdown, and particularly a large fall in the stock markets in the US and most other countries, has also inevitably depressed the sentiment of Chinese investors.

Sixth, China's stock market has accumulated a large rise over past two years, and profit taking at high levels of stock prices seems to be a reasonable choice for many investors.

The first 3 factors are attributed, or at least related to the government's reform initiatives, while the last 3 being cyclical ones.

With regard to the 4th, it is worth noting that though the performance of hi-tech companies has worsened, overall interim performance of listed companies has actually improved. According to the Guotai Junan Securities Company, one of the largest securities houses in China, the average interim profit of China's listed companies is expected to have grown by 19%. Meanwhile the interim results of 282 companies that have been released so far show that earnings per share of these companies grew by 7.9%, among which 100 registered an over 100% profit growth. The 100 companies with warning on loss and the 67 with warning on profit only account for 8.8% and 5.9% of total listed companies respectively. Thus overall, the latest correction cannot be attributed to the performance of listed companies.

There is no doubt that the reform efforts are to blame. But given the high PE ratios and rampant market irregularities, a downward correction in China's stock market is actually desirable and intended by the Chinese government, in view of bringing down the PE ratios and reducing the associated risks. Hence, to a large extent, the latest correction is initiated by the government.

On the other hand, the government certainly does not want to see a collapse of the stock market, given its implications for social stability with a huge number of investors being retired or stepped down workers. Thus while what is the bottom line for the government is unclear, it is a reasonable assumption that the government would slow down or even reverse the reform efforts, if necessary, to prevent the stock market from hitting the bottom line.

Cyclical adjustments should also have a bottom. An over 20% is already a large correction, and amid continued strong performance of the Chinese economy, this should not be far from hitting the cyclical bottom.

Therefore there should be a limit to a further correction, with probably another 5% fall and 1800 as the bottom for the Shanghai Stock Market Composite Index for this cycle.

Meanwhile a substantial recovery is not anticipated in near future. The market would enter a quite long period of adjustments, with the stock prices staying at the lower levels not far from the bottom in the coming year.

As to longer-term prospects, however, I am still confident that China's stock market will enjoy a more rapid growth and more exciting period in the coming decade. For more details, please refer to the No. 7 Issue of the Business Intelligence --- China titled "Emerging and Transforming Securities Industry in China", which is to be distributed in the coming week.