China's Stock Market Collapse Is Nothing New – Here's Why

Guild Investment Management |

The western press has been full of news about China’s 30 percent market fall and the Chinese government’s strong reaction to firm up share prices. China has seen several 30-percent market declines before the current one. Some of the declines since 2000 include declines that began in, 2001, 2005, and in 2008, which after a strong rally was followed by another 30+ percent decline in 2009. We would like to focus on the declines that took place after the economy really began to rocket ahead in about 1998 (after a big correction in 1997). 

The current Chinese government behavior is not unique -- China has often intervened to stimulate the stock market during previous market declines. 

The Decline of 2002 

In 2002 to 2003, the government was active in many ways to stem market declines. Transaction taxes were cut, foreigners were for the first time allowed to buy mainland Chinese stocks, and a World Trade Organization (WTO) agreement allowed a lot of foreign competition in China. 

The Decline of 2004 

In 2004, new liquidity was injected into the Chinese economy, interest rates were sent down to about 1 percent, and the IPO (new issue) market was completely shut down for about a year -- all to stop the market decline. 

The interventions of 2002 and 2004 failed to get the stock market rising in either case, but during this time the economy kept chugging along and moved ahead very vigorously. The consumer was not adversely affected by these stock market declines. 

The Decline of 2008 

Next, the market rallied strongly, from 2006 through the beginning of 2008, and then began to fall. The government, after a period of quietude, again began to support stocks aggressively. Massive liquidity was pumped into the economy, lending became very easy, stamp duties on securities transactions were eliminated, major institutional investors were pressured not to sell positions, and the IPO market was shut down once again. 

Stocks did not recover, immediately but consumer remained strong and GDP grew nicely. 

We have three points to make. 

1. Since 2000, the Chinese government has intervened during every stock market decline of 30 percent or more to keep stocks from falling, and at the same time has worked to create incentives for stock investing

2. These interventions have historically been unsuccessful in creating an immediate effect of higher stock prices. Stock prices have always risen, but in our view this has not been due to government incentives but instead due to attractive valuations for stocks. 

3. Historically, Chinese GDP and consumer spending have not been adversely affected by stock market declines. 

Investment implications: Chinese stocks are now at more reasonable levels than they were just one month ago in mid-June. Many good companies sell at reasonable prices. We anticipate that the Chinese economy and stock market will move ahead over the intermediate term. In the short term the market will continue to be volatile.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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