Tea Leaf Nation
Experts: Keep Calm After China’s Latest Stock Market Plunge
They say the drop has more to do with technical issues and a herd mentality than anything else.
On Jan. 4, Chinese stock markets offered a rude greeting to the new year. The benchmark Shanghai Composite Index closed down 6.86 percent, with trading paused, then eventually halted as part of what analysts are calling “circuit breaking” measures that shut down trading after major losses. Meanwhile, major indices in the United States, Europe, and elsewhere in Asia are sharply down.
Chinese stock markets were much in the news over the spring and summer of 2015, when a huge rally, followed by an almost equally huge plummet — and a clumsy government effort to prop up prices — made world headlines. And while China’s economy is far from contracting, its growth continues to slow. Against this background, Foreign Policy asked experts to place the Chinese stock market’s recent volatility in context. Stephen Roach, a Senior Lecturer at the Yale School of Management, was previously Morgan Stanley’s chief economist; Chen Zhiwu is Professor of finance at the Yale School of Management; Yukon Huang is a Senior Fellow at the Carnegie Endowment and was previously the World Bank’s country director for China; and Bill Bishop publishes the influential China-focused newsletter, Sinocism.
Foreign Policy: What does the drop in Chinese markets on Jan. 4 mean for China’s economy and its animal spirits?
Stephen Roach: Fears of a Chinese hard landing are vastly overblown. To the extent the [global] markets are discounting such a negative economic scenario, they could be pleasantly surprised.
Chen Zhiwu: Given that the Chinese economy needs a stock market boom to further stimulate business startups and entrepreneurship, any sustained stock market decline is negative for the economy and its animal spirits. Many analysts had expected China’s central bank to lower bank reserve requirements and/or interest rate cuts over the past weekend but did not get any, plus [there is] negative sentiment about future economic growth prospects, so the selloff took place today.
Yukon Huang: China’s stock market has never mirrored developments in its real economy. Until 2014, the indices did not rise despite a near doubling in the size of the economy since 2007. Expectations shifted only when traders were persuaded that the government wanted equity prices to rise in mid-2014. The market is still suffering from the mistakes made since then in talking up market expectations to unrealistic levels which then led to last summer’s crash. The subsequent recovery over the past several months level has continued to be supported artificially by government actions. Now that some of the restrictions on selling are lapsing, speculators are cashing in on the recent market rebound.
FP: What’s causing the drop — is it just turmoil among major oil-producing states? Something else? Is this rational, or an over-reaction?
Bill Bishop: The Chinese market almost never trades on economic fundamentals or global economic or geopolitical events, so I highly doubt today’s move had anything to do with the Middle East. The six-month lockup imposed on the forced purchases of shares during the [government’s attempt at] market rescue last summer expires this week, so there is a lot of possible imminent selling pressure. Perhaps people wanted to get out ahead of those expected sales and that turned into a bit of a stampede, exacerbated by the new circuit breaker.
Roach: Monday’s sharp sell-off in the Chinese market is traceable less to the economy and more to market technicals, with the latter apparently exacerbated by the introduction of new circuit-breaker triggers plus the looming expiration this Friday of the six-month selling ban put in place during the market rout of last summer.
Huang: Expectations that the growth slowdown will soon bottom out are unrealistic. GDP growth will likely continue to decline over the coming year to around six percent before leveling off. Thus those looking for something positive to cling to will be disappointed. Moving to a more flexible exchange rate has introduced additional risks. Further depreciation of the renminbi is a likely consequence, but many will interpret this as further evidence of a weakening economy rather than a necessary move to more realistic valuations. This will add to the negative perceptions shaping trends in the equity market.
FP: Do the “circuit breakers” the government has installed actually work?
Chen: The circuit breakers created a new and unnecessary anxiety, which clearly played a role in making the fall fast and sustained. As everyone knew at what level of loss the breakers would kick in, they wanted to sell before it would be too late, making the expected loss become reality much faster than it would have otherwise.
Bishop: Perhaps, as some of the jokes going around China’s Internet say, today’s drop was a “test” of whether or not the circuit breakers work. Another test will be market open Tuesday. Will the selling continue? The animal spirits were damaged last summer, but they are still strong.
FP: What do you project the impact will be on global markets in the short and long term?
Chen: The A-share loss by itself, even if it is sustained for longer, will not have any impact on the global economy or markets because of the tight restrictions on foreign investors’ participation in China’s A-share market. However, the loss as a symptom of underlying Chinese economic problems is what is causing international markets to tank. The structural problems in the Chinese economy will continue for a while and get worse before they get better.
Bishop: There has been over-reaction in the global markets, as the Chinese stock market is barely relevant to the Chinese economy and quite irrelevant to the global economy and global markets. Other issues in China, specifically the health of the overall economy and whether or not there is a significant renminbi devaluation, should have much bigger and real impacts on global markets.
Image: Johannes Eisele/Getty
Correction, Jan. 4: The Shanghai Composite Index closed down 6.86 percent for Jan. 4. A previous version of this article cited a 7.02 percent drop, which applies to the Shanghai Shenzhen CSI 300 Index.