Should You Worry About the China Stock Selloff?

China Stock Selloff

The potential Grexit may have hogged recent finance headlines, but a much bigger problem is unfolding to the east. China, the world’s second largest economy, has experienced more than a 25 per cent market drop over the last few weeks, fueled as investors, spooked by a slowing real estate market and growing debt levels, pull their investments from the stock market.

Some economists say a Chinese financial meltdown could be as bad, if not worse, than the 2008 U.S. economic downturn, the effects of which are still rippling across the world. Perhaps most worrying are comparisons to the events that led up to the market crash of 1929 and the Great Depression.

Built on Borrowed Money

Speculation, the same beast that pushed the U.S. markets to near collapse, is what has been driving the Shanghai Stock Exchange (SSE), which has doubled in value over the last year. This is mainly due to an increase in margin financing, in which investors use borrowed money to buy shares. The practice was only approved by the China Securities Regulatory Commission in October 2011. In that short period of time, Goldman Sachs estimates margin financing has reached 2.2 trillion yuan, or 12 per cent of the market, and 3.5 per cent of GDP, stating both are “easily the highest in history of global stock markets”.

Retail Investors Are Driving The Rally

Unlike in the U.S, where institutional investors were blamed for meltdown-inducing speculative trading, retail investments have propped up the rally in China. These are regular Joes, like me and you. In fact, 90 per cent of investors in China are small-time “mum and dad” investors. Many have little or no financial and trading knowledge. As well, many have borrowed against their home on margin. They’ve taken these risks to invest in a market that, for the last few years, was on an unstoppable upward trajectory. Now, as markets slow, many of them are at risk of losing their homes and, in some cases, their life savings.

Also read: Online Trading – Buying My First Stock>

Are Bigger Forces At Play?

Remember the old adage: “Sell on rumour, buy on fact”. Conventional trading knowledge tells us that once information about a company is out, it’s already too late to make money on any given stock. Many suspect the government has actually been orchestrating the stock rally. Hot tips and rumours from unreliable sources are driving investors’ decisions to sell or buy certain equities, as well as countless state media reports cheering the stock market as an example of Beijing’s visible hand. It is true that Beijing has been trying to revive the comatose stock market for years; it is perhaps giving too much credit to the power of the Chinese Communist Party to suggest it has the power to switch on and off the world’s largest stock market.

Also read: Will Rising Global Bond Yields Mean Higher Mortgage Rates?>

China Is Too Big To Fail

China has the largest stock market in the word – bigger than the S&P 500 and far bigger than the Toronto Stock Exchange. With the world still recovering from the 2008 market crash, and now embroiled with the debt problems of E.U. member nations, some are comparing this era to the years leading up to the Great Depression. I don’t believe that’s what’s happening, but with the world so fragile from other financial problems, a further decline of China’s economy could be devastating to global recovery. In that sense the problems in Greece, although serious, pale in comparison to the damage a major slowdown in China’s economy could have on the world.

What is clear is that Beijing does not have the appetite to deal with another major economic problem while it still struggles to contain the fallout from a slowing property market and a large build-up of debt in the country’s financial system.

Related Topics

Economic News / Growing Your Money / Savings / Savings News

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