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
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.
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It allowed hard-hit companies to halt trading; at some point, more than half of Shanghai-listed stocks were frozen. It limited sales by insiders. It banned short selling. It encouraged would-be issuers to \”voluntarily\” delay their IPOs. It put down-limits on stocks.
It was have helped all this by the central bank, which at the end of June cut its rate – the fourth time since November – inside a clear attempt to shore up investor confidence.
All of the was accompanied by a full-on public relations campaign. In official and quasi-official communications, \”stability\” and \”confidence\” would be the words of the day. (A statement in the Association of Chinese Asset Managers on June 30 in the midst of the selloff cheerily predicted \”sunshine follows rainy days.\”)
It’s easy to understand why Beijing is so interested in protecting its markets. Unlike free airline, retail investors comprise a large portion of stock exchange participation. Everyday Chinese – or at least the vast sums wealthy enough to invest – have been losing their shirts, and a full-on meltdown could lead to all kinds of political headaches for the government.
For a time, the intervention worked. It didn\’t.
Markets on Monday tumbled precisely due to fears that the central government would pare back its cost support. Policy, not fundamentals, is driving Chinese stock markets.
If that heard this before, it should. Investors in the West are not above sucking in the government teat when confronted with a crisis. However the kind of direct gerrymandering Beijing has undertaken is unprecedented by measure. And it comes with a basket of risks for investors.
There\’s the basic risk the interventions just won\’t work and panic will ensue anyway; billions of yuan will have been wasted.
There\’s valuation risk, because China\’s recent market distortions allow it to be well-nigh impossible to accurately value stocks – that was a difficult enough task anyway, given the lack of transparency in corporate China.
There\’s significant added capital risk, too, thanks to trading controls. Western investors have been exiting China over the past few weeks for anxiety about getting their investments secured.
Then there is the overriding problem with governments playing these confidence games: in a certain point, they have to turn off the taps of support. What goes on then? We\’ve got a taste of the answer on Monday.
Yet there is something more troubling, a minimum of to those long-term investors who\’ve watched the gradual maturing and liberalization of Chinese markets over the past few years.
Chinese regulators have been inching towards more open use of mainland markets, and had introduced a number of reforms (for instance, on margins and short selling) that would bring them into the international fold.
A good sign of that evolution was the near-inclusion of Chinese A-Shares through the MSCI Emerging Markets index captured.
That evolution has now been diverted. We ought to hope it has not been derailed.