By Jason Galanis
China’s stocks dropped 7.4 percent on Friday, as many individual stocks dropped 10 percent. The Chinese market has had a couple of weeks of rough pricing slides. The Shanghai Composite is currently in a correction mode. It has fallen over 12 percent in the past week. However, even with recent slides, the Shanghai Composite is up 30 percent for this year.
Analysts are surprised at the market boom, since corporate profits for average Chinese companies are lower than they were a year ago. The recent gains are not based on fundamental sound financials but more on government stimulus programs and investor excitement. Many believe that the market has become too overheated and may be due for a serious correction. Chinese citizens tend to save more than most, and they had been investing in the real estate market. Since that arena has peaked, they are now putting their money in the stock market. The excitement may have caused a stock market bubble for China.
A major factor in the huge gains that have been seen in the Shanghai is the extremely high level of margin buying. This is when investors borrow money to buy stocks. In a declining market, investors can lose more money than they invested, causing major financial and economic problems for the investor. If investors suffer, the economy will slow even more. Margins reached 8 percent of the markets free float, which is a very high level.
If the Chinese stock market suffers from the same over exuberance that the real estate market did, investors may be in for some painful times ahead. The main group of people to suffer the most if the markets continue down will be individual investors. China’s economy has already begun to slowdown. A stock market downturn would cause the decline to accelerate, even with economic stimulus from the government.