Chinese Market Crashed – Why you should care!

First Published on 14th July 2015

I’ve never been on Wall Street but I care about Wall Street for one reason and one reason only because what happen on Wall Street matters to Main Street – Ben Bernanke

The Greece crisis has lost its charm to Chinese equity market crash, the financial experts are now more worried about Chinese economic stability than Greece debt crisis. Chinese equity markets just lost nearly 33% in last one month, yet the Shanghai index is up by 23% year till date. So how much does Chinese equity markets lost last month? Any guesses…!! It was just 150% of India’s gross domestic product, yes nearly $3,000 Bn has been evaporated.

The Chinese equity markets started to gain momentum mid of last year with the expectation of monetary easing by the People Bank of China (PBoC). The Chinese economy has been slowing down from last few quarters with PMI numbers remained close of 50, at times below 50, which indicates the contraction in the economic activity. That said, markets seem to neglect what was happening on ground levels and started to gain on expectation of extra-ordinary steps by Government and Central bank to fuel the economy. The Shanghai index rose nearly 150% in just one year period. This astonishing rally came under light of 4 times interest rate cut by PBoC to 4.85% level and increasing participation by the retail investors. The margin trading remained the first choice of the retail investors, who did not think twice to pledge their real estate to invest in equity.

The Chinese equity markets showed the classical quality of bubble, investors keep on buying irrespective of the underlying values of asset. The prices continue to raise despite the significant downward correction in earnings. Apart from announcing market friendly steps government has been involved in cheer leading the stock markets. Hence the government has a major hand in the bubble formation, which is exactly the reason why government has put its weight behind the market. The Chinese government has delayed the IPOs, allow companies to halt trading in their stocks, allowed pension funds to invest in equity markets, the forced brokers on a buying spree, increase the restriction on short-selling.

In these difficult times, everybody wants to ask a very important question. How fire sale in Chinese equity markets will affect the Chinese economy?  To answer the question lets assess the depth of participation of retail investors. Only 7% of the Chinese population is involved in stock market trading, fairly lower than US and Europe. Most of the retail investors have less $15000, exposure to the stock markets. Hence the current level of retail participation should not be a source of worry. The Chinese financial markets are still much closely managed by the government, which gives it enough fire power to stabilize the market in the medium term.

At last, the current situation in China has enough fire-power to push the world economy towards another great depression, but one should not forget how US FED stabilize the markets after the stock market crash in 1987. 

Source : Bloomberg, CNBC