Chinese Stocks vs. the Chinese Economy

China's market has taken over Greece as the No. 1 macro concern

In the past 72 hours, the collapsing Chinese stock market has taken over Greece as the No. 1 macro concern for markets, even amid Thursday’s relief rally. But why is the Chinese stock market in freefall, and more importantly, does it really represents a potential global market headwind?

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First, it’s important to differentiate what’s going on in the Chinese stock market vs. the Chinese economy.

The Chinese stock market went simply parabolic earlier this year thanks to 1) increased access to investors and 2) speculation (obviously).

Late last year the mainland Chinese stock market was “linked” to Hong Kong, allowing foreign investors, via Hong Kong brokerages, to buy mainland China shares for the first time. That introduced an enormous amount of liquidity into a relatively thin market.

The chart here of the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR) shows just how parabolic the run higher in mainland shares was—and how quickly this bull came tumbling down.


Additionally, Chinese stocks benefited from a rotation from one bubble into another. Anyone who has watched the Chinese stock market and the Chinese economy for any time knows there was a housing bubble fueled by speculative investment dollars.

Well, over the past year that bubble popped as Chinese housing prices declined. So, investors pulled money out of real estate and “switched” it over to another bubble — the Chinese stock market.

These two forces (increased access and increased speculation) combined to send the Chinese stock market up nearly 60% at their peaks in 2015 (60% in less than half a year!). Now, that rally is unwinding in a big way as Chinese shares have fallen over 30% since mid-June — a crash by any standard.

The decline in Chinese stocks isn’t relegated to the A-shares market, either.

Even the biggest stocks in China, such as the ones in the iShares FTSE China 25 Index Fund (FXI), have been slammed this week.


Interestingly, the crash in the Chinese stock market has come at the same time as economic fundamentals in China have started to firm for the first time in over a year, and that’s part of the problem.

Chinese housing prices have finally started to stabilize, and economic growth appears to be trying to do the same — and that’s leading to investors pulling money out of frothy stocks to go back into real estate and other investments, which is exacerbating the Chinese stock market collapse.

Importantly, this decline in Chinese stock prices has been extrapolated out to imply a collapsing Chinese economy, but that is simply not the case (at least according to the data).

The falling market is a product of liquidity and reverse speculation, not macroeconomic fundamentals. So, it’s important to differentiate what’s happening with the Chinese stock market versus what’s happening with the economy.

Now, I am not trying to downplay the potential risks of the crashing Chinese stock market nor am I being dismissive. But oddly, amid this carnage, there are actually quasi-encouraging signs for some stabilization of growth for the Chinese economy.

Finally, I realize some people will take issue with this logic, and that’s OK, but China as a major, potentially destabilizing force on the global economy doesn’t really concern me, and here’s why:

The government owns everything.

The biggest banks and brokerage firms in China are owned by the government. If they go under, become insolvent or need a bailout, it’s just the government bailing out itself.

If a group of stock investors lose their money and the brokerage firms pay them out, it’s just the government’s money being distributed to the investors. And, if the losses get bad enough to where the Chinese government feels the pinch (which is almost impossible) then they can always print more yuan.

I realize that’s over simplifying the issue, but the idea of a Chinese catastrophe is over promoted.

Again, because it’s not a free market, at the end of the day everyone is government-backstopped — and the government is backstopped by the printing press.

Tom Essaye is Editor of The 7:00’s Report, a daily “cheat sheet” on the markets that’s delivered by 7 a.m. and readable in 7 minutes.

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