Everything you need to know about China's stock market collapse

If China slows down, that inevitably impacts on the entire global economy. Anyone who exports to China will take a hit.

If China slows down, that inevitably impacts on the entire global economy. Anyone who exports to China will take a hit.

Is this really all about the Chinese stock market then?

China’s stock market collapse has sparked fears of a sharp deceleration in the world’s second largest economy. But it’s not all about China. The recent slump in Chinese shares has certainly been brutal. The Shanghai Composite Index is now down by around 60 per cent since June. Yet this is merely giving back some of the spectacular gains in share prices made over the past year. After several years of going sideways Chinese stock prices exploded around the middle of 2014, shooting up by 150 per cent in just 12 months. Even with the falls of the last two months the share index is still up 60 per cent on its level in June 2014.

What comes next?

Many market participants are expecting one or more central banks to ride to the rescue in the near future to help restore confidence. This could take the form of action from the Chinese central bank to pump up growth by making it easier for Chinese banks to lend money to companies. Alternatively the Federal Reserve may get cold feet and delay its first interest rise. It’s also possible that stocks could bounce back.

Many traders are on holiday in August meaning trading volumes are relatively thin. In these markets changes in sentiment tend to have a much bigger herding effect. It’s possible that when more traders return they may take more sanguine view of the prospects of companies that make up the global indices and prices may recover.

It’s not clear what put a rocket under Chinese stocks but it seems to have been related to easier credit becoming available for small investors. These are the crucial players. Small individual investors make up around 80 per cent of the Chinese stock market, far bigger than their share of stock markets in developed countries where institutional investors such as pension funds and insurance companies are dominant. And small investors are more prone to panic.

In any case, the correlations between Chinese stock market and Chinese GDP growth are weak. Just because shares tank it doesn’t follow that growth will too. There was a spectacular Chinese stock market bust in 2007, when equities fell almost 70 per cent over the next year. But throughout that period GDP growth actually accelerated.

So what’s the problem with China?

The concern is the slowing of the real Chinese economy. China is a huge economy, second only in size to the United States. And as an emerging economy it contributes a huge amount to global growth. Indeed, it is forecast by the International Monetary Fund to be the biggest single national contributor to global growth over the coming five years.

If China slows down, that inevitably impacts on the entire global economy. Anyone who exports to China will take a hit. We already knew China was slowing. Growth in 2014 was 7.4 per cent – the slowest since 1990. And the IMF expects growth to dip to just 6 per cent in 2017.

But there are signs things could be getting worse more quickly than even those forecasts. A survey of Chinese manufacturers last week pointed to the weakest level of activity in August since 2009. And earlier this month the Chinese authorities devalued their currency by 4 per cent in just two days. Many traders took that as a sign that the economic authorities in Beijing have got wind of something far worse- and sold their stocks in response.

How will this affect the rest of the global economy?

The great fear as far as the world economic outlook is concerned is global deflation – falling prices –stemming from China’s slowdown. Deflation is very bad news for global GDP growth and, by extension, the stock price of almost all global companies. The IMF expects global growth this year to be 3.45 per cent, slightly up on last year. But still down considerably on the 5 per cent seen in 2013.

Resource: The Independent, August 24, 2015

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