It’s been a breathtaking past few weeks for the Chinese stock markets. Conditions have been so frothy for so long that the recent downturn is almost a welcome dose of sanity. I am just starting to dig into what exactly is going on over there. Below are a few of the better articles that I’ve come across, along with some of my observations.
- Everything You Need to Know About the China Stock Market Bubble. The Felder Report
- Chinese Firms Put Cash to Work in Stocks. Wall Street Journal
- U.S. Dot-Com Bubble Was Nothing Compared to Today’s China Prices. BloombergBusiness
- Guide to China’s Market Turmoil. New York Times
- Chinese Investors Who Borrowed Are Hit Hard by Market Turn. New York Times
- China’s Stockmarket Crash – Uncle Xi’s bear market. The Economist
- China’s Stockmarket Crash – A Red Flag. The Economist
- China’s stock market is now worth over $10 trillion. CNN Money
- Three charts explaining China’s strange stock market. CNBC
Notes and observations:
1. The market is dominated by Chinese retail “investors.” The scale is astounding, with 200 million individual retail traders. These individual investors account for as much as 90% of daily stock trading turnover, in contrast to most developed markets where institutions account for most of the volume. The pace of activity has also accelerated, with 30 million new accounts opened in the first 5 months of 2015. Moreover, many of these new traders might not even have graduated from high school, which would suggest that a lot of unsophisticated folks with perhaps little reason to even be in the market have likely suffered the brunt of the recent decline. They are certainly trading a lot, and at high frequency, with an average holding period of approximately one week. According to the CNBC article, total trading activity for 2015 year-to-date has already surpassed all of the activity from 2014. Most of the pain will be borne by Chinese traders, as strict regulations have limited foreign investors to only ~4% of Chinese shares.
2. Margin financing is prevalent. Margin financing in China reached $355 billion at the peak, which represents 12% of the value of all freely traded shares on the market and 3.5% of China’s GDP. The use of margin financing has also increased in the U.S. to over $500B as of April 2015, but it would seem that the rules in the U.S. around margin requirements are more established and the overall pool of tradable securities is much larger. In the U.S., my understanding is that per Regulation T, the initial margin can be set up to 50%, and the maintenance margin can be up to 25%, but that individual brokerages may choose to follow more conservative rules. Based on the demographics of Chinese traders from the earlier point, I would also assume that the typical trader in the U.S. is more sophisticated about using margin than the typical trader in China. In fact, I’m still not quite sure what the specific rules around margin trading in China even are, though it would not surprise me if the margin rules are looser in China.
3. The Chinese government seems to be doing everything it can to stem the bleeding. I’m trying to find an article or chart that provides a timeline and explanation of what the government has done, but so far have been unsuccessful. Suffice it to say that all intervention options are being considered, if they haven’t been implemented already. The central bank has cut interest rates. Short selling has been disallowed. Large (5%+) shareholders in listed companies have been banned from selling shares for at least the next 6 months. The major brokerages have created a fund, with backing from the government, to buy shares and support blue chip companies. Margin requirements have been relaxed. With all of this manipulation and activity, it would be very tough to believe any signs of a rebound.
4. The financial impact is significant, and the effects will be felt in other sectors and markets. China’s stock market had a combined market capitalization over $10 trillion, per CNN Money. The Shanghai Stock Exchange had a market cap of $5.9 trillion, while the Shenzhen Stock Exchange had a market cap of $4.4 trillion. Consequently, a 30%+ decline in China’s markets represents approximately $3 trillion of market value lost. When compared to the major U.S. exchanges, NYSE ($19.7 trillion) and NASDAQ ($7.4 trillion), this amount is large but not particularly extreme. However, when compared to other stock exchanges around the world, this is quite significant. Whether in Europe or in Japan, none are larger than $5 trillion in market cap. With such concentration among Chinese retail traders, it wouldn’t be surprising to start seeing indications of that pain spilling over into other areas of the market. In the U.S., the news have been dominated by Greece and Europe, perhaps because the impact to the U.S. is more apparent. However, even though most foreign investors are not directly impacted by China, the situation there would seem to warrant a lot more concern.