The Chinese stock market is once again in the news providing new superlatives. Just when we thought that the Chinese government had flexed its muscle to prove it could rule the markets, the Chinese stock market plummeted by 8% today.
The drop marks the largest one-day decline since February 2007, exceeding daily figures that we saw during the stock market crash last month.
The drop marks the largest one-day decline since February 2007.
The Shanghai share index dived more than 8%, stocking renewed fears that a bubble may (again) be bursting following the meteoric rise in Chinese shares over the past year.
Specifically, the Shanghai Composite Index closed down 8.5% at 3,725.56, while the CSI300 index of the largest listed companies in Shanghai and Shenzhen plunged 8.6 percent, to 3,818.73.
The majority of listed companies were hit. Index heavyweights, including China Unicom (600050.SS), Bank of Communications (601328.SS) and PetroChina (600028.SS), slumped by their daily downward limit of 10%.
Searching for Explanations
Pundits have proposed a couple of factors which may have led to the dismal performance. Firstly, the crash may have been spurred by renewed fears for the Asian heavyweight economy following mediocre data on profit at Chinese industrial firms, also released today.
Gary Herbert, Fixed Income Portfolio Manager at Brandywine Global, adds: “A principal risk that is not being considered by most investors is the structural decline in growth rates in China. When we look at retail sales, rail car shipments, vehicle sales – they are at effectively Depressionary levels.”
However, the scale of the decline represents a sudden overreaction to such data. Moreover, the value of the stock market is notoriously disconnected from the underlying economic reality.
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Secondly, some analysts said the decline was sparked by brokerages restricting credit used to finance stock purchases, also known as margin trading, according to the New York Times.
“The continuous check on margin trading by security companies has triggered today’s sell-off,” said Xu Xiaoyu, a market strategist at China Investment Securities. “In addition, the recent economic data shows it still takes time for the economy to recover from its sluggishness.”
The crash comes on the back of spectacular movement in June. After the Shanghai gained more than 150% over the past year, it all came tumbling down on June 12, 2015. By July 9, the market had fallen by 30%.
Following the crash, the government made a concerted effort to halt downward movements; cancelling IPOs, creating a fund to soak up unwanted shares, banning institutional investors and major shareholders from selling, suspending trading of some firms and attacking shorting stocks.
Many thought that the intervention had done the trick. Chinese share markets had recovered around 15% since then, before today’s renewed slump.
Keeping It in Perspective
But perspective is key. While the market has been blighted by superlative levels of volatility in recent months, the market remains significantly up since the beginning of the year. While those traders who came late to the party have been wiped out, many traders have simply seen a part of their profits cut.
While the stock market volatility is high by absolute measures, it is dwarfed by the context in which it is taking place.
Moreover, relatively very few Chinese are exposed to the market. It’s true that most trades (about 85%) on the Chinese stock market are made by individual retail investors, rather than institutional investors, and less than 2% of Chinese shares are owned by foreigners. However, only about 50 million households of China’s 1.35 billion citizens are invested in the market, furthermore, only 10-15% of their total wealth is tied up in shares.
Thus, while the stock market volatility is certainly high by absolute measures, it is dwarfed by the context in which it is taking place.
For traders, the main question is what to expect going forward. Perhaps the share of uninformed, speculative traders will be reduced and the value of the stock market will start to be better informed by the underlying performance of the listed companies and the economy.