After a spectacular rise of over 150% in one year, adding $6.5 trillion dollars in wealth to China's investors, China shares have fallen 28% from their peak as of July 3rd. It is not clear when the decline will end.
Beijing has accelerated intervention to stop the market decline. Over the weekend, China's 21 largest brokerage firms announced a plan to spend $19.3 billion USD to attempt to stabilize the markets after weeks of free fall. The firms will directly buy stock funds as long as the Shanghai composite is below 4,500. The plan could add a floor to the market by boosting sentiment in the short-term, but it is hard to know whether $19 billion, 0.23% of total market capitalization, will have a measurable effect beyond a temporary boost in sentiment. The PBOC also announced it will "provide liquidity assistance" to brokerages via the China Securities Finance Corp., directing funds to non-bank financial intermediaries for the first time. Additionally, IPOs have been delayed in order to keep liquidity in the market to help stabilize share prices.
The primary reasons for China's spectacular stock market volatility are: 1) Most of the surge has been driven by new investors piling into the market. 2) Stock prices have been highly disconnected from the real economy, driven nearly completely by behavioral factors. 3) Margin debt has skyrocketed and fallen, first adding leverage and then forcing sales. 4) China has $21 trillion in savings deposits and a very limited history of investment losses; a lot of investable capital and limited risk aversion.
China's equity markets are operating in the realm of extreme behavior driven investment. The markets have disconnected from the real economy (see my blog posting" China stock market returns and the real economy. Just how disconnected?") and rational behavior seems to have been overwhelmed by exuberance, greed, and panic. Making a forecast on where share prices will go from here in the short-term would be pure speculation as irrational behavior is impossible to predict. See my blog posting "China's stock market surge by the numbers." for more info.
That being said, given the share price disconnect from the real economy, a continued stock market decline may have very limited consequences on the real economy. Consumption and stock prices have been negatively correlated for the last year. Many Chinese have put off spending to divert money into the hot stock market. Losses (up to a certain point) may introduce risk into the market and convince Chinese consumers to divert income back to spending. Production and investment have also decelerated during the market surge over the last year. $6.5 trillion USD of wealth creation had no positive effects on real economic activity over the last year. In fact, that massive wealth creation has inhibited consumption growth. It is likely that a loss of some of that wealth will not drive down that same economic activity.
Some interesting points on China's stock market roller coaster ride:
- Bloomberg estimates that individual investors accounted for 80% of recent stock market transactions. As of the end of May, new market investors increased 83% from the previous year, according to Blomberg. 4.4 million brokerage accounts were opened in the last week of May.
- Margin debt reached a total of $330 billion in June, and over the last month has fallen to $220 billion USD as the market collapse forced selling.
- The value of all of China's shares from May 2014 to early June 2015 increased by a total of $6.5 trillion USD, nearly as large as the combined GDP of Germany and the UK. $6.5 trillion USD equates to a paper wealth increase of $4,800 for every person living in mainland China over the last year. That number has fallen to $4.2 trillion in wealth created over one year to July 3rd. $6.5 trillion of wealth gained in a year, and $2.3 trillion of that wealth lost in one month.
- China now has roughly 90 million stock investors, roughly 8.5% of the population.
- In the first 6 months of this year, 188 new companies listed on the Shanghai and Shenzhen exchanges.
- The Shanghai index trades at 15 times earnings, compared with 11.9 times for the MSCI EM index, according to Bloomberg.
- According to Capital Economics, foreigners own 1.5% of China's shares. The volatility and pain from losses will be primarily felt by domestic investors.
- Retail sales and Shanghai stock prices have been negatively correlated by a measurable amount over the last year as consumers delay spending and divert funds to stock purchasing.