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China's Stock Markets Are Collapsing, and the Freak-Out Could Get Worse

Experts warn that Chinese equities are likely to fall further, and note that the effort to intervene and stabilize values could prolong the overdue correction of a market that was clearly overheated.
Photo par An Ming/EPA

Chinese authorities are scrambling to assuage the fears of panicking investors who have seen their stock holdings plummet in recent weeks, with the country's markets losing about a third of their value in the last month.

Shanghai's composite index fell nearly 6 percent on Wednesday alone. Shortly after opening, markets across China fell so quickly that trading in more than half of the equities listed in Shanghai and Shenzhen were halted at the request of companies in order to prevent further decreases.


Though the dramatic opening losses ­— the Shanghai composite was down as much as 8 percent within minutes of opening — grew less severe by closing time, the latest turmoil has prompted China to implement measures aimed at clamping down on selling. But experts warn that equities are likely to fall further, and note that the government's effort risks prolonging the overdue correction of a market that was clearly overheated, with the Shanghai composite index rising more than 150 percent and Shenzhen's index tripling over just the past year.

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On Wednesday, the China Securities Regulatory Commission ruled that controlling shareholders, executives, and managers who hold more than five percent of any company's shares would not be able to sell any holdings for the next six months. In a statement, the commission said the decision was made in order to "maintain stability of the capital market and protect the legal rights and interests of investors," adding that any violations will be "treated seriously." Regulators had previously instructed listed state-owned companies to not sell any of their shares, and earlier this month limited initial public offerings.

Analysts have for months warned that China's equity markets were a bubble waiting to burst. The dramatic rise in equities was fed by a sharp increase in margin trading, in which stocks are bought with borrowed money, and millions of new retail investors. Encouraged by the Chinese Communist Party to buy stocks, entrants to the market with little or no experience trading or even a high school education have poured their savings into exchanges and leveraged their purchases with money they didn't actually have, which is now magnifying their losses.


A stock investor monitors equities on an electronic screen at a brokerage house in Beijing. (Photo by Wu Hong/EPA)

According to the China Securities Depository and Clearing Corp, there were 181.5 million stock-trading accounts in China in 2014 — more than double the amount a decade ago. In June, authorities reported there were more than 90 million personal investors in China, a figure higher than the 87.8 million who are official members of the country's Communist Party.

"Last year, Beijing was clearly encouraging people to invest in the stock market," Nicholas Consonery, Asia director at the Eurasia Group, told VICE News. "Prices were very low and it looked like it was a good market to invest into."

Consonery said that by March and April of this year, the government realized that stock prices were dangerously high and began scaling back its exhortations. Yet indexes continued to rise.

"My view is that the pricing story got out of the government's control," said Consonery. "They went up way too quickly and way too high, and we are seeing the painful correction now."

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The messaging from Party leaders and official news outlets in the past few years also coincided with the leveling out of a property market boom, which had been viewed by middle-class Chinese as a sound way to secure their wealth.

"Chinese authorities have engineered a slowdown of the housing market over the last two or three years," Angel Ubide, a senior fellow at the Peterson Institute for International Economics, told VICE News. "Housing was the main destination for Chinese savings, so there has been a rotation from the housing market.… Part of those savings has moved to the equity market."


The focus on stocks was part of a broad effort to transform the way the country's companies raise money and how everyday Chinese secure their long-term future. For many years, Chinese companies have heavily relied on debt to finance their activities. By promoting the stock market, Ubide said, authorities could kill two birds with one stone: push enterprises to the relatively less opaque environment of raising money through equity sales on exchanges while encouraging everyday Chinese to buy up that equity for the long-term in the manner of other industrialized countries, where retirements are often partly or wholly invested in stock markets.

A stock investor takes a nap beside a line of computer screens showing stock prices at a brokerage house in Beijing. (Photo by Wu Hong/EPA)

Signs of the growing bubble were everywhere over the past year. In one case, a property developer called Shanghai Duolun Industry switched its name to P2P Financial Information Service Co. Ltd. Despite having changed nothing of its underlying business, the company's stock immediately rose 10 percent over two subsequent trading days, and likely would have further had it not reached a limit on a single-day rise. Some observers have claimed those daily limits — 10 percent moves in either direction on a given day halt trading of a stock — are preventing some investors from de-leveraging and forestalling the natural correction of equity prices.

But despite exerting strict control over many parts of the Chinese economy, authorities watched last month as markets began to unravel. Since June 12, stocks listed in the Shanghai composite have fallen by more than 32 percent. In that period, more than $3 trillion in wealth has been lost among investors, equivalent to more than eight times Greece's total debt — a concern that up until now has dominated financial headlines. Still, the recent fall isn't as sharp as that which occurred starting in 2007 during the global financial crisis, when Chinese stocks lost more than 70 percent of their value.


Even accounting for the recent collapse in share prices, the Shanghai composite index is still up more than 50 percent in the past year. But since Chinese continued to invest at the market's frothy heights, the pain of lost savings is acute among countless investors, especially those that opened margin accounts. Making matters worse, many of those who put their money into stocks in past years are members of the country's relatively new middle class, or have little formal education. These investors might now be alienated from further taking part in the shift toward stock exchanges that has been pushed by party officials.

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According to a study released by China's Southwestern University of Finance and Economics in March, the highest level of education attainment among more than 80 percent of "new investor households" was a high school degree or less. More than half of that group only had junior high school degrees, and a full quarter only finished elementary school. Even among pre-existing investor households, who were found to have roughly double the capital of new entrants, more than half only had a high school degree.

For those who have invested for the first time, as well as the middle class that was urged to buy stocks, the sting will be lasting, said Consonery.

"There are a lot of affluent middle-class investors that are ultimately going to be on the losing end of this market correction — that's an unfortunate reality," he remarked. "It will have some impact on household wealth."

"The big question politically is what does this mean for [financial] reform," he added, acknowledging the concern among analysts that the government will prioritize economic intervention over the implementation of market-based policies. "People believe the administration of president Xi Jinping is moving toward financial reform, and I still believe they are trying to find ways to move forward."

Follow Samuel Oakford on Twitter: @samueloakford