Chinese stock markets are in complete collapse right now, with the main Shanghai Composite index losing 30% of its value in just the past three weeks. This article explains why it has happened and what it means for other stock exchanges around the world.
The above edited excerpts, and the edited copy below, is from an article* from businessinsider.com entitled Here’s a simple explanation of why Chinese stock markets are in free fall right now which can be read in its entirety HERE.
A huge amount of money has been put into Chinese stock markets over the past year or so by millions of regular Chinese people, something the government has encouraged, and this rush of money into Chinese stocks has coincided with a surge in the benchmark Shanghai Composite, which had risen over 150% since the start of last year when it peaked in June.
Why Has This Happened?
Unfortunately, however, the companies whose share prices were rising were going up simply because there was so much demand and people were bidding prices up. When the cracks began to show in the share price of a few notable Chinese companies earlier this year, the SSEC went into free fall which unleashed the biggest problem of all — margin calls.
Most of the retail investors who put money into shares weren’t using their own cash, but using their money as collateral to borrow way more money than they had to invest. This is known as leveraged investing. When investors are forced to sell shares to pay back the money they borrowed (i.e. bought on margin) to cover the losses they had incurred it causes a vicious circle of selling creating “panic” and pushing down prices even further.
Chinese brokerages went all in on this but when prices went down the brokerages that had advanced all this money (approx. 9% of the exchange’s entire worth) asked investors to put up more cash to cover the fall in value. While sophisticated investors would have the resources to do this and the understanding to calculate whether it was worth the risk most retail shareholders just sold the stock they had already bought, using this cash to meet the fees. That’s now creating the opposite problem of the one that inflated the market — a wealth of sellers, pushing down prices.
Even though the Shanghai Composite has fallen off a cliff in recent weeks, it looks as if the fall will continue, as repeated efforts by the Chinese government to stem the losses have failed, and Citi calculates that just one out of four leveraged investors has been driven out of the market. Plenty more have yet to be flushed out.
What Does This Mean For Other World Stock Exchanges?
The panic is now starting to spread to other markets that haven’t been hit by the same problem. It doesn’t look as if this will end well.
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