Lessons From The Great Fall Of China

Things have gone from bad to worse in China. Despite numerous desperate measures to prop up the ailing stock market, Chinese shares continue to plunge.

From its June peak of over 5,000 points, the Shanghai Stock Exchange Composite Index has crashed by over 30%. The smaller, but no less popular, Shenzhen Stock Exchange Composite Index, has lost 40% of its value.

From recent peak through to its latest trough, the UTEF SSE 50 China 100 ETF (SGX: JK8) and the db x-tracker FTSE/Xinhua China ETF (SGX: HD8) have fallen almost 20%, while the db x-tracker CSI300 UCITS ETF (SGX: KT4) has slumped 30%.

Trillions have been wiped off the value of Chinese companies. Some private investors have lost their life savings… and more, if they had borrowed money to buy shares.

The falls have happened in spite of (or as a result of) panic measures by the Chinese authorities to stem the slump. These have included a surprise cut in interest rates; measures that allow pension funds to invest more in stock market assets and a relaxation of rules on margin financing.

Other initiatives include pushing more money into state-owned banks; a pledge by a sovereign wealth fund to buy shares; a pause in new flotations; pumping yet more money into margin lenders; the setting up of a stability fund and a ban on big investors from selling shares.

More than half of Chinese-listed companies have now suspended trading of their shares. The suspension is unprecedented, particularly for a major stock exchange.

Whilst the suspension of share trading on such a massive scale is unparalleled, stock market crashes are certainly not exceptional, especially when shares are grossly overvalued.

One year ago, the Chinese market was valued at around 12 times earnings. That was ostensibly cheap. Last month, the valuation had surged to over 30 times earnings, without any obvious evidence that company profits were improving three-fold.

Today, Chinese companies are collectively valued at around 20 time earnings, which is still quite pricey. So it is quite possible that Chinese shares have further to fall.

There is now talk of contagion.

But rather than speculate about contagion, focus instead on valuation.

If we bear in mind that investing is working out what an asset could be worth over the lifetime of the asset, then we shouldn’t go too far wrong. Speculation, on the other hand, is trying to guess what the market could do next, which is a recipe for losing money.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.