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What can traders learn from the Chinese stock market crash?

The recent equities meltdown in China sent global stock markets reeling, with Chinese policymakers (arguably too late) introducing a range of measures to steady the market. But the broader implications of a Chinese stock market correction are far-reaching for traders.

The Chinese stock market is certainly significant in terms of its aggregate volume, but it becomes less significant when one considers that approximately only 15% of Chinese households are invested in the stock market. This does not diminish the importance of Chinese equities on global markets, but it paints a balanced picture of how equity markets impact on everyday Chinese households. In a nation of 1.35 billion people only 50 million people have invested part of their financial portfolios in Chinese equities.

The performance of the Chinese stock market is an important barometer of overall economic sentiment in Asia and the world. Since China is the world’s largest consumer of commodities – and by dint of that dictates commodities prices – what happens in China is paramount. Up until June 2015 the Chinese stock market had rallied as much as 150%, but performance slumped soon after as the Chinese juggernaut started running out of steam. As the economic growth rate of the Chinese economy slowed, so too did demand for global commodities.

The crisis in Chinese equities was so severe and so dramatic that equities prices slid precipitously, by as much as 33%. This prompted a series of sweeping initiatives by the Chinese government via regulatory authorities to implement a series of tight controls to prevent a further rout of the equities markets.

Wide-ranging measures were adopted such as banning shareholders with more than five percentage points invested in companies from selling their equities for a period of at least six months. Further, the authorities relaxed controls on capital financing to make it easier for investments to be made in equities.

Troubling response to equities collapse

The Chinese government went further, creating a massive emergency fund from the country’s biggest fund managers worth billions of dollars. Added to that were additional emergency measures by as many as 1300 companies which stopped all trading of their shares to prevent a further slump in stock prices. These measures had the desired effect of stemming the haemorrhage of Chinese equities as calm gradually returned to the markets. But there are analysts who believe that policymakers in the country were instrumental in inflating the prices of shares, but were ill-informed when it came to responding to the dramatic equities collapse.

In fact since 12 June 2015 equity values have plummeted by $2.8 trillion. These dramatic and unprecedented capital outflows are benefiting another major global economy on the subcontinent – India. Since the outflows from China began, India has been the recipient of $705 million in global investment. As a result, traders invested in the S&P BSE Sensex index have recorded a 7% gain.

Major fund managers have been reducing their exposure to Chinese equities in recent weeks, and shifted part of their portfolios to Indian equities. A big part of the problem with trading in equities is the domino effect. When major players begin to sell, other traders assume that they have access to privileged information and attempt to exit the markets before their portfolios lose value.

Despite the massive sell-off, the Chinese stock market is still significantly up since January. This means that performance for the year remains positive, but it also means that traders are at risk of further losses. Volatility also means that the upside potential remains intact and, with the Chinese government closely monitoring the equities markets, short-term gains are indeed possible. Remember, the Chinese economy is in the midst of transforming from an export-driven powerhouse to a domestic consumer-centric economy. By tapping into the domestic potential of the market, massive economic growth can ensue.

Speculators have had a hand to play in the recent success of the equities markets in China. Bank lending has been a real problem in China, and funds were diverted from the real economy into equities. This defeated the purpose of government policy which was to invest in Chinese infrastructure. After the equities market collapse, the government in Beijing decided to intervene by stabilising the index. By buying shares of Chinese companies, the government and fellow traders have brought a modicum of stability back to the Chinese stock market.

The sheer value of stock losses in China is mind-boggling – upwards of $4 trillion during one period of trading was recorded. The fact that the Chinese government has made Shanghai the symbolic centre of the Chinese success story is worrying. Should the stock market collapse, the Chinese success story symbolically collapses too. At the heart of this important economic paradigm is the need to drive up domestic consumption levels in China. With a burgeoning population, increased personal disposable income levels, and global investment pouring into the domestic sector, China is indeed a profitable paradise for traders.

Trading ideologies in China

It appears that the Chinese have switched trading ideologies over the years. From a socialist-style system of socio-economic and political governance, the Chinese are gradually but inexorably moving towards a market-based capitalist system. While the government certainly controls the lion’s share of economic activity and enterprise in the country, its role has diminished over the years as a free-market mentality largely pervades the Chinese consciousness.

Therefore the trade-off in China has been one from a repressive socialist-style command economy to one which is more market-driven. With regard to the profit potential of these changing times, traders will certainly be keeping an eye on Chinese GDP, PPI, unemployment figures and overall equity health before going long or short on trading opportunities.

Brett Chatz

Published: 28 July 2015

You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.

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