China’s confidence game: How investors are paying the price for believing

Joe Chidley: Markets on Monday tumbled precisely because of fears that the central government would pare back its price support. Policy, not fundamentals, is driving Chinese stock markets.

For a communist country, China has done a lot of things right economically. In the last three decades, it has liberalized the domestic economy and exposed the borders for trade, assisting to lift hundreds of millions of citizens out of poverty (per capita GDP has a lot more than tripled since 1980) and creating a global powerhouse.

China\’s stock market: After quick 8.5% crash, confusion reigns

It\’s days like Monday that reassure Tony Hann he was to avoid stocks in mainland China. The seriousness of an 8.5 per cent drop in the Shanghai Composite Index isn\’t good enough, but what irks him the most is not knowing why it tumbled so much

Read more

But this transformation has not always gone smoothly, to say the least. And it may well get a lot rougher if what\’s happening in China\’s stock markets lately is any suggestion.

China\’s two major exchanges – Shanghai and Shenzhen – on Monday lost 8.5 and seven per cent, respectively. It was the largest one-day selloff on Shanghai since 2007, however the markets have been reeling for some time.

What\’s happened in China may be severe, but it is no more severe than what has happened on the quasi-regular basis in stock markets all over the world. Simply put, a bubble has deflated. That\’s what happens to bubbles.

Yet since markets started falling in mid-June, Beijing has sought to shore up stock values with a multi-pronged assault of intervention. A long-term investor might ponder whether the cure is worse than the disease.

On June 12, the Shanghai composite was up nearly 60 percent on the year; the smaller Shenzhen was up a lot more than 120 per cent.

There wasn’t a real good fundamentals-based reasoning for your run-up. It was driven by liquidity, as investors – many of them small retail investors, encouraged by dovish monetary policy and official government pronouncements about the wisdom of investing in stocks – piled into the game.

And then your bubble burst, for around as much reason because it went up to begin with (i.e., not significant). In three weeks, Shanghai plunged by more than 30 percent, Shenzhen by nearly 40 percent. Chinese investors lost trillions.

Stocks remained as up about 70 per cent year over year by mid-June, but Beijing stepped in with heavy boots.