What happened to China and the World Markets?

The Chinese stock market fell by 6.86% on the first trading day of the year, triggering a trading halt for the entire day. This sent a shockwave through the entire global equity market, to Europe and the US, and now back to Australia.

I am still not convinced on the reason for this latest crash. Remember, triggering a trading halt — which is essentially a stop-loss for the stock market — is not an easy thing to do. It only occurs when there is extreme volatility in the market.

The question is why now?

Most people are pointing to the proposed lifting of the restriction on insider selling on previously halted stocks. Remember back in the winter of 2015, China placed historic bans on institutional investors, forbidding them from selling their holdings.

That rule will be lifted in the coming week. This has triggered a pre-emptive selling by retail investors. I believe this is another case of the market ‘over-selling’.

Many analysts have pointed to the ‘circuit breaker’ of putting a trading halt of 15 minutes after a 5% drop (before halting the entire market after 7% drop) as a contributing factor to yesterday’s fall.

That’s correct. However, I think the circuit breaker did its job well. I think retail investors will now factor in a potential trading halt in their decisions. This would potentially change trading behaviour and temper (to some extent) the contagious selling behaviour in the future.

What’s important to understand today is that China is going through a bottoming process and the market is overreacting to a change in regulation.

That sent a shockwave through the global equity markets.

Remember, China is all about regulatory and policy changes. The global market may need to get used to it.

Now there are several contentious points that can overthrow my relatively benign view on the latest drop in the Chinese market. One is that China is in fact not growing at 6.5–7%. It’s growing at a much slower pace. The official figures have been lying to us.

That would explain sudden drops like yesterday. However, we know yesterday’s drop was not solely influenced by the weaker manufacturing activity reading. It was more about regulatory changes and financial reform.

And if I’m wrong about a bottoming in energy prices — which could potentially still drop by another 50% — this would send prices lower in China. This would undermine pricing and profitability, which in turn would prolong negative feedback.

When it comes to energy, we obviously need to look at Saudi Arabia and Iran. But I will leave that for another time.

Finally, there’s always the possibility that China’s financial system reform becomes so badly managed that the world will see more — and larger — shocks from the Chinese financial system.

Ken Wangdong

Emerging Market Analyst, New Frontier Investor

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