Gravity has recently gripped Chinese stock markets very severely and the main Shanghai Composite index has lost over 1/3rd of its value in just about a month. The turmoil is now spreading not only to other global stock markets but also to forex and commodity markets.
The carnage in Chinese stocks is due to millions of ordinary Chinese citizens buying into shares with borrowed funds, which inflated prices to levels totally unjustified by fundamentals.
This lasted for some time before the tide turned late last year and prices began to decline. As the selling began, many people stopped buying shares from borrowed funds. On the other hand, as the share price didnt move further higher, investors were forced to sell shares to pay back the cost of borrowed funds.
With lack of buying support from fresh investments from genuine investors drying up completely and flurry of sell orders from leveraged investors, prices came crashing like nine pins.
This vicious circle continues till today and is only intensifying day by day, creating panic among investors worldwide.
A huge amount of money has been put into Chinese stock markets over the past year or so by Chinese people, something the government has encouraged. Currently there are 9 crore “retail” investors – ordinary people who own stocks – in China, making up 80% of total shareholders. The rush of money into Chinese stocks coincided with a surge in the benchmark Shanghai Composite, which had surged 150% since the start of the year 2015 when it peaked in June.
However on other hand, not even 3% Indians have direct exposure to equity stocks and hence there is no froth in our markets. Companies having exposure to and are dependent on China and other global markets will feel the heat temporarily. The recent fall is a good opportunity for investors to accumulate good quality stocks and build a strong long term wealth creating portfolio.