China & The Stock Market: What You Need to Know Before You Invest

in Investing by

KEY POINTS
  • Debt and speculation have contributed to China’s recent stock boom, which has altogether collapsed at new extreme lows.
  • The Chinese government has invested in hundreds of billions of dollars in shares, trying to force the market back into an incline.
  • Protect yourself with a diversified portfolio.

It feels like we encounter more bad news about China’s economic situation nearly every day. The Chinese stock market remains roughly 35% below its high, being blamed by many for the recent market correction and spreading concern around the globe. And as the Chinese government attempts to restore the faith of investors through volatile markets, you may be wondering how the current situation in China could affect your portfolio.

Where China Stands Today

Let’s start with a breakdown of what has happened in China recently. Local stock markets, which rapidly rose over the past year, have fallen at an astonishing speed, creating what some have called “the biggest stock market bubble since the dot-com boom.” China currently represents over 16% of the global economy. Both of China’s stock exchanges have dropped since hitting a peak early this summer.

While substantial amounts of money in share value have disappeared since mid-summer, the Chinese market still reflects gains for the year due to a rapid rise through June. But extreme drops are scaring away investors, and a growing number of them are halting trading in order to prevent further losses. And with the central government devaluing the Yuan this August, it’s possible that things in China may be worse than advertised.

China’s Market History

Over the past year, the world has watched as China’s markets grew an unprecedented amount in dollar terms. The stock boom was fueled by numerous factors, including debt, media promoted stock buying and speculation, and perhaps most significantly by a huge influx of novice investors with little education opening new trading accounts into the market.

We’ve seen China’s markets crash in the past, but never oscillate between such extreme highs and lows as recently. While China’s markets grew extraordinarily quickly, the economy cooled down, growing at its slowest pace since 2009. That level of disconnect between the market and the economy is unusual, and this relationship has been the source of anxiety for investors and companies. Margin financing and lending likely fueled the economic crises’ sudden occurrence.

The last significant Asian financial crisis happened in the late 1990’s. At the time, economists believed that the ailing Asian economy could slow growth in the US, but those years turned out to be some of America’s most prosperous. Financial crisis in Asia “led to the return of investment capital back to the developed world, which helped boost stock markets, lower interest rates, and power faster growth.” A difference this time around is that China pulls more weight in the global economy, meaning it could more easily affect global growth.

Chinese Government Response

The Chinese government has attempted to curb damage done to the market and to China’s reputation. The government cut interest rates several times this year, stopped new IPOs, and halted state-owned companies and controlling shareholders from selling their shares. They even spent upwards of $235 billion dollars to buy shares, hoping to lift up prices, while imposing intense restrictions on the sale of stocks.

The government has lent billions to brokerages to purchase stocks, and continues to produce positive propaganda about the state of the market. These assertive tactics have been met with mixed results, but generally do not appeal to investors hoping to see freer and more open markets in China.

The Chinese Vs. American Market

China’s markets are quite different from the American stock market, making the potential bursting of a bubble tricky to understand. China’s stock markets didn’t open up until the 1990s, and as a result are much less developed. There are also significantly fewer investors than in the US – only 6% of people in China have investment in stocks, compared to more than 50% of Americans.

Professional money managers control the bulk of trading in America, but in China average citizens with fewer funds and less trading experience are more important. China’s markets are very policy driven as well, and the media has a huge impact. Sharp rises and falls occur as non-professional investors react to media and try to interpret policy. This challenging environment is a large reason that China’s markets are among the most volatile in the world.

China And Your Finances

With an increasingly interconnected global economy, investors around the world are worrying about the impact that China’s economic turmoil. But, should a banking crisis emerge in China, it wouldn’t greatly impact western banks, given that Chinese banks aren’t highly integrated with the rest of the world. And outside of materials and energy, China doesn’t buy much from the US or most of the rest of the developed world. Exports to China represent less than 1% of US GDP and less than 10% of exports, according to the US Census Bureau.

But while we can all make predictions, it’s a mistake for anyone to be too confident about what will happen in China. There is also upside potential if the country stabilizes and accelerates, but only time will tell what’s next.

How To Protect Yourself: The Importance Of A Diversified Portfolio

When markets are volatile, a diversified portfolio is the best defense. Make sure to diversify globally, as well as spreading your portfolio across varying asset classes, industries, and styles to limit risk should one area of the capital markets take a serious hit. Whether China will pose a significant threat to US stock prices or not, volatile times make for a great reminder to take a moment to reassess your overall investment strategy.

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Jane Handorff

Jane Handorff

Jane is a 3rd year student at Dartmouth College working as a Marketing Intern for Personal Capital.

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