Don’t panic! Timely advice on China’s $ 3.2 trillion stock market crash

Don’t panic! Timely advice on China’s $ 3.2 trillion stock market crash
OPINION: The sudden decline in stock values in China is alarming, but the outcome may not be as hard on New Zealand as some people fear.

The value of stock markets rise and fall in a cyclical fashion. Often the higher the rise, the bigger the fall. What is happening in China is similar to what happened in the US in 2007/2008, though there are a number of differences due to the involvement of the Chinese Government both in terms of stimulating the growth in investment and now interfering to retard the decline.

Much of the rise in the Chinese stock market’s value can be put down to the Government’s loosening of regulations allowing investors to use borrowed funds to buy stocks (margin trading). The increased consumer demand and resulting increase in stock values created even more hype which encouraged less sophisticated novice investors to gamble in the stock market with their savings, or double their bet to make even more money by borrowing against their assets to get a bigger piece of the potential gains.

As a consequence, money has flooded into the Chinese stock market over the last year, pushing stock prices well beyond what could be economically justified, and between June 2014 and June 2015, the stock prices were pushed up 150 per cent. It’s easy to understand the enthusiasm from unsophisticated investors – $1 million dollars invested at the beginning of June 2014 could have been worth $2.5 million a year later.

The sudden surge in the Shanghai Composite Index would have been viewed with suspicion by more experienced investors who will have taken their gains and cashed out at the expense of the new investors.

The Chinese Government felt compelled to step in and tighten regulations around “margin trading”. It also cracked down on the use of WMPs (wealth management products) to fund stock market investments, including the new limit which came into effect on June 12 on the total amount of margin lending stock brokers could do. This in turn created nervousness and share values tumbled as  punters scrambled to cash up their gains or just get out before the losses got worse.

Huge growth in stock values is not sustainable if not underpinned by broader economic gains, and as is well known, the Chinese economy has been slowing down in recent years. In such circumstances, the sudden surge in the Shanghai Composite Index would have been viewed with suspicion by more experienced investors who will have taken their gains and cashed out at the expense of the new investors.

Undoubtedly, those who have invested in Chinese stocks recently will have lost money, especially if they were leveraged. Many smart investors however, will have made money. Given the 150% increase in stock values over the previous year, the 32% loss of value over the last month will still have left many investors well ahead.

It is likely to be the more sophisticated investor that has been and is investing in New Zealand, so we are unlikely to see a slow up in that area. Indeed, the situation in China may well lead to more Chinese investors looking to invest offshore in safer foreign markets, and in this respect countries like New Zealand which offer an open economy and freehold title to property, will be an attractive option.

Furthermore, relative to the Chinese economy, China’s stock market isn’t as large as in developed countries. So the correction of the Chinese stock market may well have less impact on the Chinese economy as a whole.

Undoubtedly, those who have invested in Chinese stocks recently will have lost money, especially if they were leveraged. Many smart investors however, will have made money. Given the 150% increase in stock values over the previous year, the 32% loss of value over the last month will still have left many investors well ahead.

Time will tell if the ructions in the Chinese share market will have any effect on sales of New Zealand consumer goods in China. I suspect it won’t. The Chinese middle class is numerically huge. New Zealand exporters have only ever had the ability to supply a very small percentage of their target market and there is no evidence to suggest that this group has been depleted to such an extent that demand will be noticeably reduced for New Zealand goods.

Furthermore, the current issues in China will make local investors more cautious about their market. So in the long run, they may look to safer, more sustainable investments, rather than gambling in the stock market of high returns and high losses. New Zealand certainly looks safer than most markets. Therefore, I don’t see this affecting New Zealand in the long term, rather it may actually encourage more investment into New Zealand.

Johnathan Chen heads the James & Wells Asia Division. He was born in China but came to New Zealand from a young age, and has close ties to China and Taiwan through both sides of his family.