Q&A: Why China's stock market plunged 8 percent

AP News
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Posted: Jan 19, 2015 4:51 AM
Q&A: Why China's stock market plunged 8 percent

Chinese stocks plunged Monday after the country's securities regulator rapped three major brokerages for continuing to lend money for stock purchases in violation of rules. As punishment for extending so called "margin trading" contracts, the brokerages are forbidden to offer credit to new customers for three months.

— HOW MUCH DID SHARES FALL?

At one point Monday, the Shanghai Composite Index was down 8.3 percent. It later trimmed that to a loss of 7.7 percent. Share prices of brokerages were hardest hit, with some falling by the daily loss limit of 10 percent. Despite the sharp fall, the Shanghai Composite Index is still up 55 percent in the past 12 months and up 33 percent for the past three months.

— WHY DID THE MARKET FALL SO MUCH?

Investors and analysts see the penalties against the brokerages as foreshadowing more curbs on credit-financed trading by China's government. Authorities want to stop the stock market's boom over the past year from turning into a bubble that could damage the broader economy. The Shanghai Composite surged 54 percent last year, partly because of easy credit that investors used to finance their trading. Market selloffs can also become self-reinforcing as other investors sell because of fear they will suffer even greater losses if they do nothing.

— DID OTHER MARKETS AROUND THE WORLD FALL TOO?

No. Even though Monday's fall was particularly steep, investors in other markets are brushing it off as a situation peculiar to China. The government allows only limited foreign investment in Chinese stocks and the country's financial system is largely walled off to the rest of the world. The exception was Hong Kong, where many Chinese companies have stock market listings. A bigger catalyst for global markets will come Tuesday when China, the world's No. 2 economy, reports fourth quarter growth figures.

— WHAT ARE MARKET EXPERTS SAYING?

"Margin financing is simply overextended," said Dickie Wong, executive director of research at Kingston Securities in Hong Kong. Regulators want to "simply give pause" to the brokerages, he said. "In the past, mainland investors had no clue on margin financing and short selling, but after China introduced these two ways to trade stocks, people became so happy because they can borrow money and just go all in."

— IS THE PLUNGE A SIGN OF BIGGER PROBLEMS?

It shows problems on several levels. Stock markets should allow investors to discover the fundamental value of companies, and although all markets are prone to under- and overshooting due to herd psychology, China's market is particularly off-course. That's partly because it is dominated by opaque state-owned companies. In their relatively short history, China's stock markets have fluctuated in ways that bear no relation to economic reality. Its latest problem is that debt has fueled the recent rise in stock prices. There are also signs of debt-related stress in other parts of China's economy including property, which is undergoing a painful government-instigated slowdown. One developer, Kaisa Group, recently missed a $23 million interest payment on a bond abroad, alarming investors.