China’s Share Market Plunges to 13 Month Low

China’s own Shanghai Composite [SHA:000001] performed terribly on the first day of trading for 2016. It dropped 6.9% on the first day of trading. And it has substantially dropped twice more since then. 7% on 6 January and yesterday it dropped a further 6.4%. The most recent drop has helped the composite reach 13 month lows. And it could be the Chinese government’s fault.

Shanghai Composite

Source: Bloomberg

Pumping money just compounded the problem

Mid last year, the Shanghai Composite was in melt down mode. The index has lost 43% of its value and was unravelling fast. The government had to do something quick before their stock market completely kicked the bucket.

The solution was simple. Banks would lend billions to big Chinese brokerage firms so they could buy more stocks. The goal was to buy enough shares to stop the stock market from crashing further. This injection of capital was the largest since 2013.

But the problem wasn’t fixed. The composite continued to drop. Zheshang Securities analyst, Zhang Yanbing said ‘even though the central bank injected funds, this money won’t necessarily go into the stock market.’ Other analysts agreed, believing the injected fund were to replace capital out flows.

It was estimated that China’s capital outflow reached $1 trillion last year. And in response the government has limited capital leaving the country. ‘We are now refusing all foreign currency transfers where the documents are not fully complete…previously the requirements were not so strict,’ said a banking executive in Shanghai.

Capital outflow jumped in December last year. The cause could be ‘the immediate trigger for a pickup in capital outflows towards the end of the year was the People’s Bank of China’s poor communication over its shift in currency policy,’ said Mark Williams, chef Asia economist. And he might well be right.

Up until this time, China used to peg their exchange rate against the US. And usually China tries to keep the yuan low to keep their exports competitive. But recently China has changed the way they set the exchange rate. China has stated that the previous day’s trading of the yuan would be taken into account. This means the market now greatly affects the yuan instead of staying pegged.

The decision triggered the biggest devaluation of the yuan in 20 years. Some believe the foreign exchange reserve could tumble as much as $300 billion this year. Slow economic growth and an unexpected devaluation have left policy makers fighting to reduce the yuan’s volatility.

The Chinese state media has even tried to discourage billionaire George Soros, betting on the yuan to fall. It seems like a ridiculous statement, telling traders how to trade. But Soros has been dubbed as the man who broke the Bank of England. Soros made US$1 billion by shorting sterling in 1992, so maybe China’s pleas could be justified.

It’s an issue about confidence and there’s no confidence in the market now,’ said fund manager, Wu Kan. And he’s completely right. Right now, negative news is being compounded by millions of investors. Analysts are adding to the fears by aggressively advising investors to sell. Managing director of Chart Partners, Thomas Schroeder says the benchmark will drop to 2,400.

Yet it’s still uncertain whether the Shanghai Composite will drop a further 14.57%. But what is more certain is the growing pessimism in our own market.

 What does China’s situation mean for Australian shares?

For the first time in a little over two weeks it looked like the ASX 200 was going to rally out of its slump. On Monday the market traded up 2% to a high of 5006.6 points. But of course pessimism has kicked in and our market has dropped again below the 5000 mark.

 ASX 200

Source: Yahoo finance

China is our biggest trading partner. We depend upon them to buy mass quantities of our minerals, finished goods and agricultural products. Thus, slowing growth or subpar economic indicators out of China really hurt Aussie companies. Adding to the problem is a downwards trending Shanghai composite. When Chinese investors aren’t confident, it encourages Australian investors to follow suit.

When will it be over? Everyone is guessing at the moment. But a declining stock market isn’t all too bad. When stock prices are declining it make them cheaper to buy. Sure, not all cheap stocks are worth buying but if it’s a really great company, then why not buy? Investors are all spooked by what’s happening in the global market. Selling out of their holdings or short selling shares because they are scared to buy into anything. But we must remember that emotions should never be a factor when deciding what to invest in.

There is a famous story of Warren Buffett giving back investor their money because he couldn’t invest in a bull market. He told investors in a note that investing in a bull market was unfamiliar to him. He believed his investment options were limited and his methods were ineffective.

So if we were to take a leaf out of Buffett’s book, a declining market would be music to savvy investor’s ears.  There are plenty of opportunities to make money. You just need to keep your emotion out of your portfolio.

Härje Ronngard,

Junior Analyst, Money Morning
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