• Understanding China’s wobbly markets


    IF the first few trading days of 2016 are any indication, it’s going to be a very long, unpleasant year for Chinese stock markets.

    On Monday, after China’s two main markets in Shanghai and Shenzhen experienced steep drops, a new “circuit breaker” instituted at the beginning of this year went into effect, halting trading in the afternoon.  On Thursday, the circuit breaker was triggered early in the session, creating what may be a world record for the shortest market trading day ever, shutting down the markets just 14 minutes and 17 seconds after the opening bell.

    China’s woes, of course, jolted markets around the world; US markets dropped about 2 percent in Thursday trading (Thursday night here), and our own PSEi shed close to 3 percent after the Chinese boards went dark.

    In the wake of the Chinese rout, the consensus that emerged from the flood of analysis and commentary is that the equities markets there are in the midst of an implosion that likely cannot be stopped at this point. Combined with other global worries such as an intensifying conflict in the Mideast and what may happen with the teetering economies in Brazil and Venezuela, a very grim picture for at least the first part of this year is beginning to emerge.

    The reasons China’s markets are going berserk are complex, and are best understood if we begin on the trading floors themselves and work outward.

    The first problem is the “circuit breaker,” which was implemented to prevent the sort of wild volatility the Chinese markets experienced in the latter part of 2015, but which is proving to be unintentionally aggravating the situation. The circuit breaker is a more-or-less automatic system based on the CSI 300 index, which comprises the 300 biggest stocks on the Shanghai and Shenzhen exchanges. If the CSI 300 drops by 5 percent from its opening, the system will pause trading on those and the other smaller exchanges in China for 15 minutes; if the index drops by 7 percent or more, as it did Monday and Thursday, the system will shut everything down to prevent further losses.

    On Monday, Chinese traders began the day under a cloud of uncertainty because of worrisome signals from the Chinese economy and other global factors, and knowing that the circuit breaker was now in force, began to ditch shares to avoid getting caught with them if it was triggered—activity which, of course, made it inevitable that it would be.

    Everyone seemed to realize they’d shot themselves in the foot after the markets shut down, and so a combination of a little self-control and bargain hunting on Tuesday and Wednesday momentarily steadied the markets. By Thursday, however, the situation had returned to approximately what it had been on Monday, and now that traders had definite knowledge that the circuit breaker would be used if things reached a certain point, the urge to sell was even stronger, and would take only a little nudge to turn into an all-out stampede.

    It collapsed so quickly on Thursday because there were two factors to destabilize the market. The first, and far smaller of the two, was a concern about the expiration of a rule by Chinese regulators that banned selling by investors holding more than 5 percent of an individual issue. That rule was put in place in the middle of last year as part of the market interventions to calm volatility, and was set to expire today, January 9. If it had been allowed to expire, a big sell-off could be anticipated this coming week, so investors were anxious to get rid of their shares before that happened.

    The second and more substantial factor was the surprise devaluation (the Chinese government, who are getting better and better at capitalist gibberish as time goes on, called it a “re-indexing”) of the yuan, which was lowered by 0.51 percent to 6.5646 to the US dollar, the biggest negative change in the currency’s value since August last year. That, of course, causes all kinds of worries—inflation and higher import prices, for example—but the most immediate concern, and one that has gotten less attention from analysts than other factors (probably due to the relative paucity of hard data about it, to be fair), is the enormous amount of debt being carried by Chinese companies. A lower currency value has the practical effect of making debt more expensive, and when that is happening at the same as signs of cooling in the wider economy like shrinking exports and lower manufacturing output, it increases perceived risk.

    Emergency measures

    In hastily called meetings on Thursday afternoon, Chinese authorities took steps that they hope will steady the markets. The ban on large-holder selling was modified and extended, and the circuit breaker, since it was demonstrated to produce exactly the opposite of the desired effect, was suspended. What effect that will have in the near term remains to be seen; the trading day began in China on Friday (this column was filed before markets closed) with a level of volatility that might be courteously described as “insane,” with more than 96 million shares changing hands in the first 25 minutes after the opening bell in Shanghai.

    The prognosis into next week and beyond is not good. There is a sense that Chinese
    regulators have gone too far in interfering with the markets, and have reached a point where they really don’t know what to do to fix the mess—implementing a purported market-steadying circuit breaker and then recalling it less than a week is not a sign of decisiveness confidence, by any means. And no matter what degree of meddling is applied to the markets themselves, none of it can change the underlying factors that made the markets nervous in the first place, and on that score, there may be real cause for alarm.

    The unexpected, rapid escalation of tensions between Saudi Arabia and Iran, and the equally surprising nuclear demonstration by North Korea—which is quickly becoming a millstone around the neck of its only significant ally and trading partner—are particularly thorny problems for the Chinese as they try to find some economic equilibrium.

    And whether it is logical or not, we have already seen that as long as China is unsettled, so, too, will the rest of the world be. Considering that we have only reached the end of the first week of the new year, indications are we may be in for some very interesting times in 2016.



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