3 Factors Causing China's Stock Market Volatility

A Look at What's Behind China's Swooning Stocks

China’s stock market has seen unprecedented volatility throughout 2015 and 2016 after the Shanghai Composite Index soared nearly 140% between June 2014 and June 2015. Since then, the index has plummeted 35% off of its highs moving into early 2016. These sharp declines included significant short-term drops in June 2015, August 2015, and January 2016, where the market fell by high single-digit or double-digit percentages and caused widespread chaos.

In this article, we’ll take a look at three reasons behind China’s stock market volatility.

3. Short-term Retail Traders

China has a high percentage of short-term retail traders rather than long-term institutional investors. According to Reuters, 85% of trades are placed by retail traders with 81% saying that they trade at least once per month. Bloomberg found that two-thirds of these investors are also uneducated and many are trading with borrowed funds. Not surprisingly, these dynamics may have contributed to the destabilization of the market given the short-term capital flight.

These factors may be mitigated in the future if the country continues to open up its domestic stock market to foreign investors. In November, the government permitted anyone in the world to purchase shares of companies listed on the Shanghai Stock Exchange, rather than only qualified individuals. The Shanghai-Hong Kong Stock Connect Program doesn’t exactly make it easy for retail U.S. investors, but more institutions may begin taking a stake in the country.

2. Global Economic Uncertainty

China’s export-driven economy generated GDP growth of around 12% by 2010, but these figures have been trending sharply downward in more recent years. By the end of 2015, the country’s GDP growth rate dipped below 8% for the first time since the 2008 economic crisis. A slowing manufacturing industry – evidenced by sharply lower industrial production – has been a driving force behind the drop, while sluggish end markets in the U.S. and E.U.

aren’t helping.

The rise of consumer spending could help offset some of this weakness as the economy transitions from exports to services. According to McKinsey & Company, discretionary consumer spending is projected to exceed 7% between 2010 and 2020, while so-called semi-necessities is expected to grow 6% to 7% per year. These figures could help propel the country’s domestic service-based economy to offset weakness in manufacturing.

1. Government Interventions

Chinese regulators have always taken a hands-on approach when it comes to the country’s economy, currency, and stock market. In July 2015, the government actively intervened in the stock market by providing capital to securities lenders, encouraging executives to buy shares, and aggressively pursuing short sellers. These activities resumed in January 2016 after a sudden drop in major indexes triggered an emergency breaker and stopped trading.

The Chinese government had promised to avoid these kinds of actions in the past, but its most recent moves suggest it was nothing more than rhetoric. Back in November of 2013, the country pledged to let the markets play a decisive role in the economy, which is has followed to some extent with letting the yuan depreciate.

Investors will be waiting to see just how this latest bout of volatility plays out and its impact on these policies moving forward.

Key Takeaway Points

  • China’s stock market volatility flared up again in January 2016 after a rout in July 2015, as a number of underlying problems remained in place.
  • The country’s stock market suffers from short-term trading, economic uncertainty, and unpredictable government interventions.
  • Some of these problems are being actively resolved through government-led initiatives designed to open up the market and transition to more stable growth.
  • International investors may want to steer clear of these markets until some of these uncertainties are resolved and trading becomes more predictable.