Recent market volatility is neither entirely warranted nor unexpected. In China, it reflects a confluence of forces; but in the US and internationally, it is fueled by international worries.On Monday, January 4, China’s A-shares plunged by about 7%, whereas the renminbi (RMB) weakened to 6.52 relative to US dollar.The CSI 300 index, which tracks large-cap stocks in Shanghai and Shenzhen, suffered the largest single-day plunge in months. The fall was fueled by soft data (Caixin PMI’s slowdown to 48.2). However, the 0.4 decline was too small for an adequate trigger.Moderate RMB depreciation, with occasional volatility, is only to be expected after recent reforms of the currency peg and the ongoing RMB internationalization.The market reaction was a strong one, but not exactly unexpected, due to the circuit- breaker effect, the expiration of a sales ban, amplified volatility, IPO tweaking and economic and international concerns.Circuit-breaker effect. Under the new circuit breaker rules, the trading of stocks, futures and options will be suspended for 15 minutes, when the CSI 300 Index falls or rises by 5%. And when the index moves by 7%, trading will be halted for the rest of the session. While such circuit-breakers have been criticized, they have proved useful internationally – and could have been quite helpful amid last summer’s meltdown.
Expiration of a ban. After weeks of extraordinary market volatility, Beijing imposed a half-year ban in July 2015 to prevent major shareholders from selling their investments. With a stake of over 5% in the A-share companies, these majors can move the market, in good or bad. The ban allowed the government to stabilize the market: at year-end 2015, the Shanghai Composite was up 10%, while Shenzhen surged 65%.
Amplified volatility. On Monday, investors were concerned that major shareholders would sell with the expiration of the ban on Friday. In China, individual investors still dominate the market, whereas institutions are the minority. Consequently, Chinese markets are significantly more volatile than those in advanced economies.
IPO tweaking. Last July, the initial public offerings (IPOs) were suspended as part of measures to end the rout that severely impaired market capitalizations. Last month, the IPOs resumed while regulators moved ahead to curb market volatility.
Economic concerns. Despite decelerating growth, rebalancing is moving ahead in China, despite periodic economic uncertainty and market volatility. That will fuel conflicts between “reformers” who demand policy tightening; and “stabilizers” who demand policy stimulus – while investors are left anxious.
It was the snowballing and confluence of these domestic concerns that led to the “black Monday” (but supported a slow recovery in China on Tuesday).
In China, the volatility is likely to continue until the ban’s deadline on Friday, possibly beyond. However, the markets are now over-estimating the threat factor in China but under-estimating the threat factor in the US and internationally.