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Insane volatility

The insane volatility in China’s markets - which has seen regular daily swings up and down of over 5% in Chinese benchmark stock indices - is spreading across to developed markets. Measures by the Chinese authorities to counteract the sell-off are actually proving counter-productive. Over 50% of Chinese-listed firms have suspended trading, and this number is likely to rise. Leveraged investors are now trapped, unable to sell any of the 1,500 suspended stocks that will inevitably be losing value with the broader markets. This forces the investors to sell other holdings which, perhaps without intervention, they may otherwise have held onto, or even bought more of, on the dip. The result is that declines are exacerbated. It goes without saying that movements in the Chinese stock market don’t necessarily correlate to China’s economy. This applied on the way up, when Chinese stocks rallied over 100% in the space of a year, while economic growth was the slowest in six years. This should also be the case on the way down. Just because stocks are crashing, it doesn’t necessarily have a knock-on effect on China’s economy.

Out of pocket

A stock market bust can, of course, leave a lot of people out of pocket, and that could dampen domestic spending, which has already been waning. Also, smaller market capitalisations will mean Chinese businesses cannot borrow as much for expansion, limiting employment opportunities and further curtailing spending. On a more positive side, retail investors make up 80% of stock ownership in Chinese shares, so losses in the stock market should not have a large, direct impact on institutional investment into the wider economy. So why are commodities - including oil, copper, silver, iron ore and associated resource stocks -crashing alongside Chinese stocks? In part, it is the same phenomenon mentioned above. Locked out of suspended shares or caught in margin calls, Chinese investors have been forced to sell other assets. Commodities are already under pressure from the prospect of a rate hike in the USA, which reduces the demand for non-yielding assets. The idea that a stock market crash could put a hole in China’s economy and reduce demand from the world’s biggest resource consumer is adding to the pain for commodities

Bubble burst

The wider concern is a loss of faith in the Chinese government. The bubble in China’s stock market was a creation of the government, and they have now unwittingly popped it. The encouragement to invest through the Shanghai-Hong Kong Stock Connect, the re-opening of IPO markets with low valuations and the expectation of easier monetary policy all fuelled a rush of buying. There was little to no consideration of future earnings growth. When Chinese authorities allowed fund managers to short sell and increased margin requirements, the red flag was waved and the smart money started distributing, while the dumb money was still accumulating. If the supposedly omnipotent Communist Party have shown such ineptitude with regard to stock markets, who’s to say the same thing won’t happen with the wider economy? If China’s authorities do lose control of the economy, it will have huge impact on global growth, and by implication global stock markets. China’s economy is still expanding faster than all developed nations, and there will be the inevitable dead-cat bounce in stock markets, but the fragility of a command economy has been exposed again.
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