With the Chinese stock market turmoil that incited global panic abated - at least for now - here are some questions and answers about it, as well as lessons to learn:
With the Chinese stock market turmoil that incited global panic abated – at least for now – here are some questions and answers about it, as well as lessons to learn:
WHY DID THE CHINESE STOCK MARKET PLUNGE SO MUCH?
China’s main stock index tumbled nearly 23 percent over five days before returning to positive territory Thursday and Friday.
It had more than doubled over 12 months from June 2014 as state media encouraged the public to invest even after economic growth began to slow. That fostered expectations the government would intervene if needed to keep the market from falling. By June, stocks were ”trading at sky-high, rocket-crazy valuations,” said Dickie Wong, executive director of research at Kingston Financial Group in Hong Kong.
Prices started to fall in mid-June after regulators tightened margin financing to limit the amount brokerages could lend to customers to trade shares. That prompted concern authorities would no longer support share prices. As those fears spread, panicky investors dumped shares. The central bank’s Aug. 11 devaluation of the yuan accelerated the declines by fanning concern the move would accelerate an outflow of capital from China, leaving less credit to finance stock trading.
Authorities responded with a flurry of measures to shore up prices, including barring big shareholders from selling and ordering brokerages and pension funds to buy. But that blizzard of announcements confused small shareholders and fueled panic. ”It gave an even harder hit to the stock market and made those local investors even more fearful,” said Wong.
WHY DID GLOBAL INVESTORS REACT WITH SUCH ALARM?
China is the world’s second-largest economy and has been a key driver of global growth for several years. Signs of a slowdown in China’s economy began to emerge earlier this year, but the market kept climbing. So when the market began to slide in mid-June, global investors began to take note. When the drops worsened and Shanghai index tumbled 8.5 percent on Monday, that spooked international investors who were already worried about the possibility of higher U.S. interest rates, prompting a global sell-off.
Most people outside China can’t even invest in the country’s stock market, but as worries persist about tenuous global growth, ”anything that suggests that the prospects look more dim is going to send equity investors running for cover,” said Lori Heinel, chief portfolio strategist at State Street Global Advisors.
IS CHINA’S STOCK MARKET A RELIABLE INDICATOR OF ITS ECONOMIC PROSPECTS?
Not really. Chinese stock markets have little connection to the rest of the government-dominated economy. The biggest companies are state-owned and their health is decided by official policy, not the market. So traders respond to government cues and the availability of credit to finance speculation. Stock prices can rise when the economy is weakening or fall even though conditions are improving. ”The plunge in recent weeks has little to do with the general economic landscape, but is merely a proper market adjustment to dispel bubbles,” said Zuo Xiaolei, chief economist for Galaxy Securities in Beijing. ”I don’t think the performance of the stock market in China is a barometer of China’s economy.”
WHAT LESSONS CAN INVESTORS LEARN FROM THIS?
For one, it’s a reminder that stock markets can and do swing wildly, and should be viewed as long-term investments for people with a tolerance of risk. After an uninterrupted four-year rise by U.S. stocks, ”I think people have forgotten that equity markets go down as well as up,” said State Street’s Heinel.
Another lesson is that China’s stock market has become big and closely watched. Though it’s a poor indicator of China’s well-being, and most of the world is shut out of it, investors need to know more about it.
Rothwell reported from New York. Kelvin Chan in Hong Kong contributed to this report.