Auto shares outperformed on news of a Chinese government plan to strengthen the sector, which may involve mergers to cut the number of major auto groups.
The Shanghai Composite Index <.SSEC> ended at a two-week closing low of 2,200.654 points, not far from the day's low of 2,193.268. Losing Shanghai A shares outnumbered gainers by 766 to 173, as turnover in Shanghai A shares rose to a very heavy 157.9 billion yuan ($23.1 billion) from Monday's 138.2 billion yuan.
China Construction Bank <601939.SS> sank 4.90 percent to 4.08 yuan and China Life Insurance <601628.SS> lost 6.40 percent to 20.92 yuan.
CITIC Securities <600030.SS> , which is the biggest listed brokerage and so is often seen as a barometer of the market's outlook, slid 9.83 percent to 22.42 yuan and Haitong Securities
<600837.SS> plunged its 10 percent daily limit to 12.33 yuan.
The index has major chart support between 2,000 and 2,100 points, where it peaked repeatedly from November to January, and analysts said there was a good chance of that area being tested.
"The market has been hit by a couple of steep falls since last week, and each has erased several days of rises. This might drive some investors out of the market," said Huatai Securities analyst Chen Jinren.
LIQUIDITY
Many analysts think stocks' rally this year was to a large degree due not to reasonable expectations for an economic recovery, but to heavy inflows of money created by monetary easing and government pressure on banks to boost lending.
New bank lending is now expected to shrink from January's record levels, which could pressure the stock market.
Merrill Lynch said in a report on Tuesday that excess money should keep China's stock market outperforming other markets, despite wobbles due to global events, until a Chinese economic recovery sucked liquidity out of stocks.
But Stephen Green, economist at Standard Chartered Bank, said stocks appeared to be on shaky foundations.
"The liquidity boom in the stock market may well come to an abrupt end if loan growth were to slow sharply; a stock market decline would in turn cause a further slowdown in loan growth as short-term speculative borrowing returned to the banks.
"This slowdown may already be happening. Given the weak state of profits, most serious observers doubt that there is much foundation to the recent stock market boom."
Green added, however, that a sharp slowdown in February loan growth could pressure the central bank into easing monetary policy again, and this might cause a second wave of liquidity into stocks.
BANKS
Banks had led the market up on Monday as Shenzhen Development Bank (SDB) <000001.SZ> jumped its 10 percent daily limit on a local media report that it might soon be taken over by China Development Bank (CDB).
But there was no confirmation of this -- CDB said it had no plan to buy SDB, which suspended its shares, saying it was investigating the report. Disappointment that a deal was probably not imminent pulled down banks from the opening on Tuesday.
A source familiar with the situation told Reuters that CDB was studying various potential Chinese bank targets, including SDB, for a possible acquisition or strategic investment, but that talks with SDB remained in an early stage. [nSHA318575]
Baoshan Iron & Steel <600019.SS> , the biggest listed steel maker, sank 5.62 percent to 5.71 yuan after senior officials at the China Iron and Steel Association delivered a gloomy analysis of the industry on Monday.
"Some people may view demand as reviving (because prices recovered in January), but I don't. The imbalance in supply and demand will continue to create an unstable situation," said Luo Bingsheng, secretary-general of the association. [nPEK314152]
Auto shares outperformed on Tuesday, with SAIC <600104.SS> down just 0.11 percent to 8.83 yuan, after the official China Securities Journal said the government aimed to cut the number of major auto-making groups through mergers to 10 at most from 14.
The government will provide subsidies worth 5 billion yuan between March and end-2009 to aid purchases of autos in rural areas, and aims to stabilise demand so that China's total vehicle sales and production this year both exceed 10 million vehicles, and grow an average 10 percent annually over the next three years, the newspaper said. [nSHA366726]
Chongqing Changan Auto's A shares <000625.SZ> surged 10 percent for a seventh straight day since the firm said it would spend up to HK$909 million ($117 million) to buy back its B shares. However, its B shares <200625.SZ> gained only 1.68 percent after rising 10 percent for six days. [nSHA321234]
Gold producers kept rising, with Shandong Gold <600547.SS> up 4.45 percent to 77.74 yuan, on speculation that the global financial crisis would boost the international spot gold price
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