A market bubble primed for pricking
Just as “bad cases make bad law,” to cite the ancient legal adage, bad stock markets make for bad investment decisions. China’s stock market, with its repeated crashes, has the entire world in a tizzy.
The Shanghai stock exchange experienced its shortest trading day ever Thursday in China, as circuit breakers designed to end trading if the market slid 7% kicked in after only 14 minutes of active trading. The Shanghai composite has dropped about 12% this year, and the Shenzhen composite has fallen more than 15%.
Investors in the U.S. took the opportunity to sell. As of Thursday’s close, the Standard & Poor’s 500 index is down 4.67% in the early days of 2016, the Nasdaq has lost 4.29% and the Dow Jones industrials have shed 5.12%. European stocks have marched over the cliff in tandem.
Yet the world should take a deep breath. The China stock market meets the definition of a bad stock
market.
The market is the target of relentless intervention by the Chinese government, which has been setting investment rules and tweaking them without any evident understanding of how open markets work. Adding to the chaos, the market was inflated by an inflow of small investors buying on huge margins — making them especially vulnerable to the market’s volatile swings.
Last April, as Evan Osnos of the New Yorker reported, the official organ of the Chinese Communist Party exhorted citizens to plunge into the market. An upsurge of more than 80% in four months was “merely the start of a bull market.” Investors should take heart from the government’s determination to keep Chinese companies strong.
“Over the next two and a half months, investors opened 38 million new stock accounts, more than quadruple the number of accounts opened in all of 2014,” Osnos wrote. “Retail exchanges, equipped with audience seating, attracted retirees and other smalltime investors who spent hours scanning the digital displays, like visitors to the dog track.”
This was a bubble primed for pricking. But that wasn’t all. On July 8, during a major market crash, Chinese regulators imposed a lockup on shareholders owning 5% or more of their companies, prohibiting them from selling for six months.
The effect of lockups is well understood in mature stock markets; they tend to create latent bearish pressures as the expiration approaches. That expiration was due Friday, plainly creating some of the downdraft witnessed this week.
On Thursday, regulators tried to keep the bear caged by extending the lockup in modified form for three more months.
The circuit breakers are another source of trouble. Introduced Monday, the rules halt trading for 15 minutes after a 5% drop in the benchmark CSI 300 index, and stop trading for the rest of the day when the index falls 7%. They were triggered on day one, and again Wednesday.
Circuit breakers exist in U.S. markets, but critics say they’re cinched too tight in China, where 5% swings have been far more common. In the U.S., trading is shut down only if the Standard & Poor’s 500 benchmark falls 20% in a day.
All these features, artifacts of the government’s inclination toward intervention in the stock market, make the market an unreliable gauge of economic trends, many critics say. (Though they’re not unanimous — last February, economists at MIT and New York University argued that the market had matured to the point that it was providing reasonably accurate signals about future corporate earnings. “China’s stock market no longer deserves its reputation as a casino,” they wrote.)
Underlying the Chinese market plunge are signs that the world’s second-largest economy is slowing down, and that government economic officials aren’t fully up to the task of managing it.
They’ve been frantically depreciating the Chinese yuan, which will put pressure on the nation’s trading partners by making Chinese exports more competitive and imports more expensive. The rapid depreciation sends a signal that policymakers are getting to the end of their stimulative arsenal.
Adding to uneasiness about government policy, no one has ever been entirely certain about the pace of China’s economic growth because its official figures are untrustworthy. Gross domestic product may have been overstated as much as threefold, some observers believe. A slowdown in the Chinese economy certainly will ripple globally, and ill-considered moves in Beijing to shore it up could have major unintended consequences worldwide.
There’s no question that cracks in the Chinese economy are worrisome, but the wild swings of the stock market may be exacerbating the panic. It makes sense for investors worldwide to keep their eye on the economy, but the stock exchanges? Just watch the ride.
Michael Hiltzik’s column appears every Sunday and occasionally on other days. His new book is “Big Science: Ernest Lawrence and the Invention That Launched the Military-Industrial Complex.” Read his blog at latimes.com/business /hiltzik and reach him at mhiltzik@latimes.com.