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Mark Mobius says Chinese stocks have risen too fast after a world-beating rally sent the benchmark equity gauge to its highest level in seven years.

A 20 percent retreat is “very possible,” Mobius, who oversees about $40 billion as the executive chairman of Templeton Emerging Markets Group, told reporters in Hong Kong. The Shanghai Composite Index rallied 90 percent in the past 12 months, the most among 92 global benchmark measures tracked by Bloomberg.

While Mobius says the bull market in Chinese stocks is “intact,” he’s turning cautious in the short term after investors opened a record number of new stock accounts and increased margin debt to all-time highs. Mainland shares are unlikely to gain entry into MSCI Inc. indexes this year, limiting demand from international investors, he said.

“It has gone a little too far and too fast,” Mobius said.

Chinese investors opened a record 1.7 million accounts to trade equities in the week to March 27, while there is now more than 1 trillion yuan ($161 billion) of borrowed cash riding on the stock market.

In a margin trade, investors use their own money for just a portion of their stock purchase, borrowing the rest from a brokerage. The loans are backed by the investors’ equity holdings, meaning that they may be compelled to sell when prices fall to repay their debt. The Shanghai Composite rose 0.8 percent at close at 3,994.81 after briefly surpassing 4,000.

Custodian Risk

“Too much credit is not a good thing in the long run,” Mobius said. “When the market turns, it could be a problem.”

He’s avoiding buying mainland shares through the Hong Kong trading link due to “restrictive” rules on share ownership.

“According to Chinese regulations, the titles pass to the custodians in China and our custodian banks refuse to allow that,” Mobius said. “That’s a problem. I don’t see how this can be resolved. The Shanghai connect won’t work unless they revise regulations to allow foreign custodians to keep possession.”

Foreign funds sold a net 2.2 billion yuan ($460 million) of mainland equities through the Hong Kong trading link today, poised for the most on record.

China is the biggest weighting in his Asian funds, followed by India and Thailand. Mobius said he favors banks on the outlook for financial reforms as well as auto and technology stocks for their growth prospects.

Bull Market

“The bull market is still intact,” he said. “It can go for five years to 10 years.”

The ultimate inclusion of Chinese shares in MSCI global benchmarks together with the nation’s capital-market liberalization will provide the market with incentives to climb further in the long run, he said.

Templeton also favors Vietnam and Nigeria among frontier markets because of their valuations and growth potential. Mobius said he recently bought some Macau casino stocks, while he’s waiting for a correction in Indian shares before increasing holdings there.

(Adds Mobius’ favored industries in 11th paragraph.)