On the subject of stock market turmoil

China’s new stock market circuit breakers forced the market to find the bottom in 7% chunks at a time this week. But, in less than 5 days, Beijing has already discarded the short-lived circuit breakers scheme, requiring Beijing to directly purchase shares and rewrite large shareholder selling restrictions to stop the panic selling.

Overnight on Thursday, markets shut within 30 minutes after a 7% drop triggered the newly created circuit breakers again for the second time this week.  The circuit breaker is a mechanism created in 2015 in order to stop panic selling. A 5% loss or gain in the CSI300 Index triggers a 30 minute trade suspension.  A 7% gain or loss in a day triggers a market closure for the day.  On Thursday the market burned through the 5% trigger, right to the 7% threshold within a half an hour, and trading was halted for the day.  

Early into Friday's trading session without circuit breaker protection, the market declined to 2%.  State funds purchased shares with large weights in the index to push the market up 2% by the close.

Some things to note about the market turmoil this week:

  • The links between China's stock market and the real economy are minimal. 90% of the market participants are retail investors, as opposed to institutional. And a major chunk of investors are new to stock investing, having opened the first accounts last year.  Institutional investors put money to work in China’s stable bond market - the third largest in the world -  leaving stocks as a venue for irrational stock gamblers. The local bond market has been both stable and strong during stock turmoil.  Only 8% of the adult population owns shares, and liquidity is massive - bank deposits in the country are 200% of GDP.  Statistical analysis shows no direct relationship between share prices and economic activity over the last few years.  A share sell-off should not be confused with a hard-landing in the economy.  The Shanghai stock exchange is the world’s largest gambling den, and should not be confused with the real economy.  Whatever your China economic growth outlook was last week, the events of this week should not change that outlook.
  • Most of the turmoil in the stock markets this week are probably a product of 3 main factors: The expiration of large shareholder sale restrictions set for this week, the uncertainty over weakening of the yuan, and the ever-present worries over growth - perhaps exacerbated by the very modest downward revision of GDP overnight or weak PMIs.
  • In order to stop the market panic in 2015, on July 8th Beijing instituted a six-month ban on share sales by investors with holdings over 5 percent in a single company, along with corporate executives and directors.  That was slated to end this week, causing most of the market carnage.  Goldman Sachs estimates that the share ban kept 1.1 trillion RMB in shares off the market.  The value of the Shanghai Composite has fallen about 6-7 times that amount this week.
  • On Thursday, after the market halt, new rules for large shareholder sales were published.  Now, large shareholders can only sell a max of 1% of their holdings every three months.  And, they must apply for share sales 15 days in advance.  The new rules might delay the panic selling from continuing in the short-term, but share sales from large shareholders will happen eventually.  Other trading restrictions still on the books: Individual shares halt trading after a 10% drop in one day, and investors are not allowed to buy and sell the same shares in a single day.
  • After spending almost $240 billion last July, August, and September - mostly through a group of a group of state-backed investors, brokerages and funds referred to as the “National team” -  to support the market, the “National team” has entered the market again.  Tuesday and Friday trading sessions saw Beijing directed share purchases to support the market.
  • Market pressures and outflows have led to a drop in the yuan this week, leaving the PBOC liquidate reserves to slow the declines.  The yuan drop has contributed to the uncertainty, but Beijing has much more control over its currency than its equity markets, with its daily trading range, closely controlled capital account, and massive reserves.

Beijing is pretty lousy at managing free market liberalization. Their policy responses seem ad hoc, frequently add to uncertainty, and often exacerbate the turmoil.  But, stock market turmoil and policy blunders should not negatively impact already weakening - but stable - economic growth and employment stability.  The real economy - already expected to slow by another 0.50% in 2016 - momentum is positive in the short-term on the back of consumption and service growth.  Beijing reflation efforts have finally started improving activity.  Don't mistake stock market turmoil with economic growth prospects.  My calculations indicate that it is highly probable that Q4 GDP will be better than expectations when announced on Jan 19th, which may be met with some disbelief.