Why is the Chinese stock market falling?

5 January 2016
You might have heard something about the Chinese stock market lately – namely that it’s crashing. This is China’s second major boom-and-bust cycle in the last ten or so years, and extenuating circumstances mean that the impact of this crash could be significant.

Is this a correction rather than a crash?

The short answer is yes. At time of writing, the Shanghai Composite is down by more than 40% from its June 12th  high point of 5166, having fallen to 3,202 on the 5th Jan 2016 – representing a fall of a whopping 7% on Jan 4th alone, as fears surrounding the health of China’s economy multiplied. BUT, to put that in perspective, the index was 3209 on August 25th so effectively the market has simply retreated back to that point. And in fact the index 12 months ago was 3,350 – so the decline over a 12 month period is not overly significant.

Certainly though if you bought at the peak last June you would be very concerned right now…

The rapid value increase of the index during the past 12 month period cannot be explained by economic growth; at the same time as the stock market boom began China’s economy was actually in a slump, growth having slowed compared to the previous few years. China’s stock market boom was driven by debt, and if you think that sounds like a bad thing, that’s because it sometimes is.

Borrowing-fuelled boom

Investing in stocks using borrowed money is known as margin trading, and until recently it was highly restricted in China. But recently the Chinese government eased up on its margin trading laws to try and stimulate stock market investment, and it worked far better than they could ever dreamed.

The period between June 2014 and May 2015 saw 40 million new stock accounts opened. The Chinese people, previously not heavy players in the stock market, flooded the stock market with borrowed money.

During the same period, the amount of above board margin trading within the Chinese stock market exploded, going from 403 billion yuan to 2.2 trillion. We used “above board” as a qualifier due to the fact that experts and economists estimate that additional funds have made their way into the stock market through a number of methods and vehicles used to circumvent the official limits on margin trading.

All of this caused the aforementioned  increase in the stock market, which raised concerns among Chinese authorities, who subsequently made moves to cap any further growth. The first half of 2015 saw a number of new restrictions on margin trading implemented, which led up to a June 12 announcement of a new limit on stock brokers in regard to the total amount of margin lending they could do. Cue stock market crash. Cue over $3 trillion worth of shares being wiped from China’s stock market, eg. approximately the value of our entire economy times two.

Will China impact us?

Is this going to affect us? Yes. Ongoing volatility in the Chinese stock market, and particularly a loss of investor confidence, has the potential to be felt by Australia. Experts are split on the size of potential impact, but if our biggest trading partner loses trillions, every dollar lost from their economy is a dollar that can’t be spent on Australian exports, which make up nearly 20% of our GDP, and of which China buys roughly 30%. So yes, our economy, and potentially our stock market, can suffer from the impact of a Chinese market collapse. At this point we can only hope for a lesser impact.

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