China's stock market plunged 8.5% yesterday, but it could've been much worse.
An estimated 1,500 stocks suspended from trading after they fell the maximum 10% allowed by regulators, according to Reuters. It was the biggest fall in more than eight years.
Weak economic data raised concerns about the health of the worlds' second-largest economy (behind the US) saw investors panic sell. Some commentators suggest that traders have lost faith that the Chinese government can slow the selling – despite a huge range of measures introduced to stem the flow as we listed here.
Those steps helped the Shanghai Composite index rise by 14% over the past few weeks.
There are an estimated 90 million individual investors in China's markets, and stocks are a relatively tiny 9% of China's household wealth according to CNBC. In other words, relatively few Chinese have been affected by the share market falls. Still, the Chinese government has unleashed an estimated $800 billion of public and private money to prop up its markets say Reuters.
The problem is the large numbers of companies still in trading halts. While the market is artificially stopped from finding its own level, instability will reign. Reuters also reports that Chinese stocks are still trading at stratospheric valuations. The Shanghai Composite is still up 100% from 12 months ago and has an average P/E ratio of 17.6x. The Shenzhen stock exchange has a P/E of 47.2x while the small-cap ChiNext growth board is a whopping 98.1x.
As David Madden from brokerage firm IG told the Wall Street Journal, "The cat is out of the bag when it comes to China, and the collapse in the stock market overnight has confirmed that Beijing's stabilization policies are not working. I feel that confidence will be difficult to get back, no matter how much money they throw at it."
The problem is that the Chinese government contributed to these problems a year ago, by relaxing credit terms and encouraged investors to buy stocks using margin loans. It was also a way for Chinese companies to raise capital reducing their dependence on the government for funding.
But officials may unnecessarily be making the issue worse by propping up the market. If you as an investor in the Chinese market know that the Chinese government is going to prop it up and stop it falling too far, that puts a base on your maximum loss, but no limit on your gains.
Chinese officials have already come out and stated that the government will continue to support the stock markets, ensuring volatility will continue. The key issue is that if confidence is lost, there's probably not much the Chinese government can do besides nationalising most listed companies, and that would have a devastating effect on China and its stock markets. The problem for Australian investors is that as confidence in markets around the world falls, it takes our market with it.
