Chinese stocks tumble as Morgan Stanley says don't buy the dip

The Shanghai Composite Index fell 7.4% to 4,192.87 at the close, bringing its drop from this year's high to 19%

Chinese stocks sank the most in five months, sending the benchmark index to the cusp of a bear market, after leveraged investors cut holdings and Morgan Stanley joined a chorus of analysts warning that valuations have climbed too far.

The Shanghai Composite Index fell 7.4 per cent to 4,192.87 at the close, bringing its drop from this year's high to 19 per cent. Chinese stock-index futures tumbled by the 10 per cent daily limit as investors rushed to hedge their positions, while the benchmark index in China's smaller exchange in Shenzhen sank 20 per cent from this year's peak. A gauge of equity volatility jumped to the highest level since 2009.

China's $8.8 trillion stock market has plunged from first to worst on global performance rankings, threatening to bring an end to the longest bull market since the ruling Communist Party introduced equity trading to the world's largest population in 1990. Morgan Stanley advised clients to refrain from purchasing mainland shares in a report on Friday, saying the Shanghai Composite's June 12 high likely marked the top of the rally. "This is probably not a dip to buy," wrote Jonathan Garner, the head of Asia and emerging-market strategy at Morgan Stanley in Hong Kong. "In fact, we think the balance of probabilities is that the top for the cycle on Shanghai, Shenzhen and the ChiNext has now taken place."

The Shanghai gauge has surged 106 per cent over the past year as investors speculated monetary stimulus will revive the weakest economic expansion in more than two decades.