Chinese equities crashed at the market open this week, despite selling ban on certain stocks, as well as restrictions on when and how investors are allowed to sell. Regulators seem intent on controlling the market, but history has some lesson about the practice.
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The Chinese stock market crashed in stages on Monday as so-called “circuit breakers” halted trade at various intervals during a market rout. An existing stock-selling ban in China is set to expire on Friday, and the country’s regulators are running out of ideas on how to stem the persistent selling.
The China Securities Regulatory Commission held an unscheduled meeting on 7 January regarding the nation’s plummeting stock market without reaching a decision on policy action.
China’s stock circuit breakers forced the nation’s exchanges to shut for a second day this week. The halt applies to equities, index futures and options.
China’s CSI 300 Index plunged 5%, on Monday, triggering a 15-minute trading halt. Investors scrambled to exit stock positions before a full-day suspension – at 7% decline – would lock them out of trading. After the initial halt was lifted, the market reacted swiftly: after only seven minutes losses reached the 7% threshold and trade was halted for the day.
A second sell-off, on Thursday, triggered the automatic shutdown just 30 minutes after the Chinese market open.
Commentators and analysts speculate that the emergency China Securities Regulatory Commission (CSRC) meeting, and subsequent suspension of the circuit breaker, was not so much about removing the shutdown mechanism as widening in thresholds amidst higher stock market volatility.
Unlike similar circuit breakers in US markets, the current CSRC threshold is low enough to have forced market shutdowns twenty times had the mechanism been in place during 2015.
CRRC Corporation, the China’s biggest train-maker, dropped 2.8% in the last seven minutes of trading on Monday, extending its one-day drop to 8.1%. More than half of Agricultural Bank of China Ltd.’s 3.4% decline happened between the two circuit breaker halts. At the trading halt the Shanghai Composite Index had fallen 6.9%.
Existing trading restrictions in China include a 10% limit on daily swings for individual stocks and investors are prevented from buying and selling the same stocks on any particular day.
The US also utilizes circuit breakers to prevent excessive market swings but has a higher threshold for automatic full-day shutdown exchanges. Trading is halted for 15 minutes on the New York Stock Exchange and Nasdaq Stock Market should the S&P500 drop 7%, and only a drop of 20% would end trading for the day.
Meanwhile, a CSRC imposed stock-selling ban on major shareholders (A-share holders) is set to expire on Friday. Under the current rules, shareholders owning more than 5% of a company’s stock are unable to sell their shares.
A CSRC spokesman, said on Tuesday that the regulator intends applying new restrictions on share sales by A-share holders that will include a predisclosure system, selling restrictions and mechanisms such as block trading and private negotiations to reduce the negative impact on markets.
As of Tuesday afternoon, at least five listed companies have promised that their controlling shareholders and senior executives will not reduce their equity holdings.
The socionomic perspective proposes that markets rise and fall in accordance with social mood. While most traditional perspectives argue that bad news or weakening fundamentals cause markets to decline, socionomics holds the inverse view: that negative social mood causes selling behaviour which then reflects in negative news stories and a perception of weak fundamentals.
Research by both Elliott Wave International and the Socionomics Institute has illustrated that selling bans and austere market regulation are bear market phenomena. Conversely, during bull markets, there tends to be a loosening of regulation and calls for greater market autonomy.
Given that Chinese authorities are intensifying efforts to stem market sell-offs by placing greater restrictions and regulations on market participants, we can conclude that the Chinese equity market is in a longer-term bear market. This assessment is strengthened by survey findings that reveal pessimism (negative social mood) toward the Chinese stockmarket.
An online survey by Tencent Holdings Ltd. reports a “strong” pessistic sentiment among investors regarding the prospects of the Chinese stock market in 2016.
61% of the 40,000 investors polled expressed a negative outlook for the A-share market. Only 22% were positive.
27% of investors attributed the circuit breaker mechanism as the primary reason for the market crash while 33% saw the lifting of the ban on A-share holders, on Friday, as the trigger for Monday’s sell-off.
Bans on selling and short selling, are a favorite trick of regulators who assume the negative bets put downward pressure on stock prices. Implementing a ban on both the cause and the effect of falling markets is, therefore, a visible signal to the public that the regulators are “doing their job”.
However, despite the knee-jerk regulatory reaction and the clockwork regularity with which they impose bans, they only delay the inevitable.
The US, along with many other countries, tried a short-selling ban during the 2008 market crash, and the failure of this measure is clearly visible in the following chart:
As previously reported in CCN.LA Global Economic Outlook even a cursory technical analysis shows that the China stock market decline still has a long way to go. Whether it will pull other economies down with it or whether the world will perhaps not miss Chinese capital finance remains to be seen.
This analysis is provided by xbt.social.
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Charts from TradingView, financial data & cartoon from Investing.com, image from Shutterstock.