Seeing the Chinese Stock Market Collapse in a Different Light

China’s Shanghai Composite Index, one of the country’s main stock market benchmarks, had rallied by more than 150% within a year from June 2014 to June 2015. It then subsequently collapsed by more than 30% from its peak in the space of less than a month (more specifically from 12 June 2015 to 8 July 2015).

The behaviour of China’s stock market was likely driven by speculative fervour. Yet, the Chinese government had intervened aggressively to prevent further market declines when the sharp falls happened.

According to a report from Barron’s Asia, some of the measures the Chinese authorities had engaged in include:

  • “Cutting interest rates and bank reserve requirement ratios
  • Suspending trading in large percentage of “A-shares” (Chinese stocks listed onshore)
  • State Council ordering indefinite suspension of initial public offerings (IPOs), ostensibly to free up investors’ funds to buy already-listed issues
  • China Securities Regulatory Commission quadrupling to RMB 100 billion the capital of China Securities Finance Company (state body which extends margin loans to brokers); and pledged that the PBoC would inject liquidity into the lender to support the market
  • Central Huijin (powerful state investment fund) buying index-tracking exchange traded funds (ETFs)
  • Chinese leading brokerages setting up RMB120 billion fund to buy stocks; also pledging they won’t sell on their own account while Shanghai Composite remains below 4,500 (it closed today at 3,970)
  • Nearly 100 fund management companies buying stocks
  • Cracking down on short sales
  • National pension fund permitted to buy stocks
  • Banning shareholders with stakes of over 5% from selling for six months”

From the point of view of market participants in developed stock markets, the scope of the Chinese government’s intervention may seem downright ridiculous. But, I believe that such judgement on the Chinese stock market is flawed.

This is because those passing judgement are using standards of a developed market to judge a market that is still under development. To use an analogy, it is akin to judging the actions of a child based on the standards for an adult. This point is made clear when one keeps in mind the fact that China’s stock market as we know today only started life in the early 1990’s while the U.S. stock market has a history of close to 200 years.

The Chinese stock market is currently dominated by retail investors as compared to more developed stock markets where institutional investors have a much larger presence. Meanwhile, the correlation between the real economy in China and its stock markets are much weaker when compared to other developed countries.

With the above paragraph in mind, the heavy-handed intervention by the Chinese government is thus – in my opinion at least – more a way to prevent excessive losses for its citizens than a way to prop up the stock market to save the economy. Huge losses may lead to social unrest – and in a country with a population of more than 1 billion, even dealing with unrest involving just 5% of the population would mean a problem involving more than 50 million people.

That’s not a trivial problem at all. From this point of view, the Chinese government’s stock-market-interventions might not seem so ridiculous after all.

Foolish Summary

The Chinese government’s way of handling its stock market is definitely uncommon from the point of view of the Western world. But, it pays to walk in someone else’s shoes too.

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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 writer Stanley Lim doesn't own shares in any company mentioned.