China Stock Crash Instills Fear, Uncertainty

July 28, 2015Stocksby EW News Desk Team

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Chinese stocks posted their largest drop in eight years as the Shanghai Composite lost 8.5% in one day of trading.

As stocks fell in Shanghai, other Chinese stock indices also posted major losses, with the Shenzhen Composite losing over 7% and the Hang Seng losing 3.3% in Monday trading, reversing much of the recovery Chinese markets saw in early July.

Chinese markets are still above their month low, with the Shanghai closing at 3,725 on Monday. That remains 6.2% July’s low, but erases most of the year’s gains and has inspired greater fears of further losses to come. Year-to-date, the Shanghai Composite is up 16.8% on a constant currency basis.

The fall has hit emerging market stocks, which have hit a two-year low thanks to a decline throughout Southeast Asia, particularly in Taiwan and Indonesia. A fall in commodities also threatens emerging markets, which expects to hit operating margins for commodity-dependent exporting countries.

Sale Ban

The fall in Chinese stocks on Monday is particularly worrying because many analysts dismissed a major bear run as unlikely due to new regulations that limited selling pressure in China.

On July 8 when the stock market reached its lowest point after the major rise earlier in the year, the Chinese Securities Regulatory Commission announced new rules that limited how many shares certain groups could sell. Specifically, the CSRC announced that any shareholder owning more than 5% of a company could not sell shares for the next six months beginning on that day, including foreign investors with large ownership of Chinese firms. Regulators also hinted that legal action, including prison sentences, could be in store for traders who aggressively shorted Chinese stocks.

Chinese stocks rallied on the news, and many bullish commentators insisted the rally would likely continue as the rule limits selling pressure. However, stocks failed to erase all of the losses they saw before the announcement of the rule, when over 30% of value was lost in about two weeks.

Monday’s steep drop in stocks indicates that the rule has been less than effective, which is causing some analysts to warn that further declines are likely in the short term. Many believed that, whether effective or not, the CSRC rule would embolden many investors to keep faith in Chinese equities.

Commodity Glut

Monday’s fall in Chinese equities follows a week of declining commodity prices, with oil futures falling sharply on indicators of growing inventories and weaker demand in emerging markets.

The trend, while beneficial to manufacturing-oriented countries like China, may also indicate weak domestic demand. Some analysts believe that the fall in oil indicates the inaccuracy of China’s official GDP growth rate, which the government says rose 7% annualized in the first half of 2015.

The fall exacerbated declines for PetroChina Company, the country’s largest oil producer, which fell 9.6% on Monday. In early trading on Monday in the U.S., both European and American oil producers also posted losses as fears of shrinking consumption persist.