Daily Management Review

5 Facts About Chinese Market Fall


The sharp fall in China's stock market is one of the most debated topics today, and at the moment, it is the most dangerous event for the global economy. No one can say for sure when the situation will stabilize, but there is a doubtless risks of worsening.

The biggest danger is that the drop in the stock market can go to the real economy, which, in fact, is the locomotive of the world economy. In such a situation, all the markets, including oil, would fall down.

In general, the fall might not happen if the stock market has not completely lost touch with reality. Its dynamics has not been reflecting the status and prospects of the Chinese economy in recent months.

Chinese stock collapse has already spread a lot of rumors and different versions of irrefutable facts in a very short period of time.

1. For the last three weeks, Chinese stocks lost 30%, while the market capitalization has fallen by more than $ 3 trillion.

Chinese trade shares dropped 51% on the stock exchanges, with a total market capitalization of $ 2.2 trillion. These are 660 companies in Mainland China.

Authorities are trying to save the situation, but the Chinese government is now using the same tactics that were used on Wall Street in 1929. Major Chinese brokers said that they, with the support of People's Bank of China, will buy shares in the aggregate of 120 billion yuan ($ 19.3 billion ) to support the market.

In 1929, Wall Street banks did something similar: JPMorgan and several other leading financial companies have agreed to pool their resources to buy up shares in order to contain the fall in value. This happened after the fall of Dow Jones Industrial Average index by 30%. However, the Bank's efforts have had only short-term effect, and the US economy finally collapsed.

Now the Chinese are actively growing indices, showing the maximum daily increase since 2009, but nobody knows how long it will be lasting.

2. The unprecedented growth of the market before the collapse

Somewhere in the middle of last year, China got a real boom in the stock. Millions of people opened a brokerage account and bought shares, practically always with the use of borrowed funds.

By early June 2015, annualized Shanghai Composite rose about 50%, and Shenzhen Composite showed an increase of 111%.

Prior to the collapse, the average daily trading volume was above average, and technical indicators, such as the deviation from the 200-day moving average and relative strength index, could be compared with 2007’ bubble.

On ChiNext, the exchange of start-ups, the ratio of stock price to earnings then reached 130, and it is twice as high as a reasonable level for such companies. The average ratio of cost and profit on the Shanghai Stock Exchange, where the largest companies are trading, is 23.

And this is despite the fact that a lot of new accounts appeared on the Chinese stock market. In just one week, the number of new accounts got up to 4.4 million.

Only in the I quarter of 2015, nearly 8 million accounts was discovered. In April, the regulators allowed a single person to open 20 accounts at once, whereas previously they were limited to only one. It is usually very profitable for traders trading intraday.

The Chinese market is filled with lots of minor players. Retail investors account for as much as 90% of daily turnover, while institutional investors are interested in more developed markets.

But many of the last year’s newcomers have been very rich. Before, the size of the trading account exceeded 100 thousand yuan ( $ 16 thousand.) only in 20% of cases, and now the share of such accounts has reached almost 40%.

3. Chinese authorities needed the Bubble Blast

Strong growth of the stock market with help of various farmers, workers, students, unfamiliar with the principles of functioning of the market, is absolutely unacceptable, according to the Chinese authorities.

Almost all of these people have been doing the usual speculation, preferring to buy and sell shares almost not storing them in the account. The average duration of securities storage in the account was less than one week, and reached one day for some stocks.

This meant a completely speculative nature of the market. In addition, the shares began to be traded on bribe takers money, who have lost access to a casino in Macau.

The overheated market is dangerous because it can explode at any time, so the fall had to be controlled. It is enough to trigger the beginning and then, because of the large amount of debt incurred for the purchase of shares, as well as the general speculative sentiment, the market is simply blown away.

For a long time, the authorities did not show much interest to the falling, which may indicate their interest in such dynamics, and the duration of this decline is also more dependent on government than on the market.

Banks actively lent to companies under the guarantee of their shares, and now they are unable to demand additional security from its customers. It's very similar to the exemplary punishment of those who did not follow reasonable risk policy. In addition, the big banks that have a more balanced approach to lending, almost do not express symptoms of anxiety.

Attitude towards foreign investors, who are simply ignored or soothed, is telling as well. This is very different from the crisis of 1997-1999 and 2008-2009, when many governments helped foreign investors to withdraw capital.

It will take quite a bit of time before Chinese citizens, farmers, teachers and pensioners realize that all their money is gone, and we can only hope that this process will take place peacefully and without riots.

According to some reports, from 20 to 40 million people may lose their money, and this may be the main reason for the Chinese government, together with the People's Bank of China, go to the most desperate and unprecedented steps for the sake of the market.
4. The market fall spiraled out of control

If the assumptions about the artificial collapse are correct, the situation seems to be out of authorities’ control. The Chinese authorities have launched a full-scale war for the real stock market.

And it is not limited with measures to stimulate purchases of shares and easing credit conditions for the purchase of securities.

First, it was announced that the largest shareholder and insiders were prohibited from selling the shares, more than half of the securities trading were stopped, IPO canceled, margin requirements reduced and so on. Some large companies are required to conduct buyback to support the quotes.

The police had even begun testing the market participants in order to find those who sell Ping An shares and PetroChina in the last 30 minutes of trading on July 8, while the government bought securities to support the market.

Now comes the implementation of the ‘national action plan’, which should allow cracking down on "illegal sellers of stocks and futures". However, it is unclear how these traders have broken the law, but at least 10 "malicious short sellers" have already been identified.

Growth, of course, will continue in the coming days, yet these actions cannot solve the structural problems of.

Of course, a further fall in stocks could lead to the widening of the crisis hurting the real economy, but it still can happen if some correction continue after the market collapse.

In the end, it is infinitely impossible to soften the conditions of entry to the market, and hence ways to support should end sooner or later.

But the most amazing thing is that all these threats and arrests have really helped the Chinese market. Usually, such harsh actions cause a wave of selling, but on Friday, the Shanghai Composite Index rose 5.2%. And this is after the maximum daily growth since 2009 on Thursday, when the index rose just 5.8%.

However, if the instability continue in the next few days, then "the new rally," as it’s called, will be just a small rebound to a strong fall.

In any case, recent weeks have clearly shown that the strong government intervention in the market does not help reduce volatility and does not imply a real stabilization.

5. The fall of the market could be repeated

The Chinese market, despite the recent decline, still shows the annualized dynamics of close to 100% growth over 2014-2015.
And it’s actually a lot, so the government may decide on the continuation of "blowing" the bubble after some stabilization. This can continue until all stop selling, or simply go bankrupt.

Yes, this approach is certainly unpleasant to market participants, but will stabilize and possibly prevent this in the future.

In theory, this drop should be relatively smooth, and is only necessary in case of further strong stocks growth.

The Chinese authorities fear that the destabilization of the stock market have a negative impact on the entire financial system and the economy, reducing consumer demand. Therefore, if a new fall occurs, it will likely be a very leisurely and gentle decline.

However, the active sellers may reappear market on the market, and the situation with the uncontrolled fall can happen once again.

source: independent.co.uk