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Print Edition> Business
UPDATED: July 21, 2015 NO.30 JULY 23, 2015
Market Watch No.30


What Can We Learn From the Stock Market Plunge?

The past month has been unforgettable for investors in China's A-share market. A sharp fall in stock index, a sudden drain on liquidity and a panic sentiment are all unprecedented in the history of China's stock market.

With the government's direct intervention, the stock market has stabilized, but it still faces the arduous task of reconstruction after such a disaster--how to improve the institutions and lay foundations for long-term stable development of the stock market. Sustainable and sound development of the stock market will depend on whether the government and all market participants can reflect on this stock market crisis in a right way.

The A-share market plunge this time, without any signs previously, forced heavily involved investors to be liquidated, blindsiding them and pushing them into a panic. How should people look upon the immediate causes, amplifying causes and primary causes for the financial turmoil? How should we prevent them?

The emergence and inflation of bubbles will occur before a market collapse. Before this round of A-share market plunge, there had been clear bubbles in the stock prices of some industries pushed by crazy speculation, and some stocks had incredible bubbles. After bubbles have formed, the market can still maintain a balance for some time, but such balance will be very fragile, easily broken by even a subtle force. Previous market operations tell us that a breaking of the balance is also unpredictable. Therefore it is useless to argue which speculative force is responsible for this round of stock market plunge. What we should do is to define the reasons causing bubbles in the market.

Also, inadequate liquidity is just a superficial reason, not the true cause of the stock market turmoil this time. A liquidity crisis is one of the symptoms of a financial crisis, and the higher the leverage is, the more serious the liquidity crisis will be. This was proved particularly in the sub-prime mortgage crisis in 2008. At the worst moment of the crisis, almost no transactions were made in the monetary and bond markets. If we mistakenly define the stock market collapse this time as a liquidity crisis, it will be very likely that the market will repeat the same mistake.

In essence, this round of stock market turmoil is a process for bubbles to burst. The A-share market used to see many times of bubble formation and burst, but this time, many new factors in the market, such as leverage, stock index futures and rapid expansion of public and private funds, make the turmoil more serious and destructive. However, the crisis is still caused by the burst of bubbles. Therefore, to ensure sound and sustainable development of China's stock market, we must eliminate the systems and institutions frequently causing bubbles, and then properly control the mechanisms that amplify fluctuations of stock prices.

The first lesson we learn is that we must obey the market rules, understand the relationship between price and value and respect such a relationship.

We must be aware that any behavior that pushes stock prices away from their respective values is dangerous. We must crack down on market manipulation and insider trading. We must also properly understand the mechanisms that amplify stock price fluctuations. We should not negate them, but these mechanisms must be well regulated. Regulatory authorities should not introduce innovative financial tools with undue haste, and they must keep abreast of the latest market data. Authorities must completely reflect on the impact of investment behaviors by public funds and formulate stricter supervision measures to prevent them from disturbing the market.

It must be noted that this round of stock market fluctuation should not hinder the market-oriented reform. A market-oriented relationship between stock supply and demand can prevent bubbles from forming. The reform to adopt a registration system for stock issuance shouldn't be postponed. Measures should be formulated to facilitate behaviors increasing or reducing stock supply.

The concept of value investment has not yet been well established in the A-share market, mainly because the rules of value didn't work well with stock prices seriously divorced from the values. Only in a highly market-oriented environment ruled by law can the rules of value work well and the concept of value investment be accepted. Otherwise, in an environment full of speculation, bubbles and manipulation behaviors, a new crisis is inevitably to come again.

This is an edited excerpt of an article published in Securities Times


61.9 mln

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Year-on-year growth in net profits of the country's 22 listed brokers in the first half of 2015


June's year-on-year growth in electricity consumption, an important indicator of economic activity, up slightly from a 1.3-percent rise in April and a 1.6-percent rise in May

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The number of newly registered companies in China in the first half of the year, up 19.4 percent from 2014

890 mln yuan

The amount of money retrieved for dissatisfied consumers nationwide, who filed 592,000 complaints, in the first half of the year

1 bln yuan

Total investment of this year's first batch of 12 projects signed by the Yinchuan Comprehensive Bonded Zone in northwest China's Ningxia Hui Autonomous Region

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Revenue from the e-magazines in China last year


Profit growth of China's civil aviation industry in 2014

Copyedited by Kylee McIntyre

Comments to yushujun@bjreview.com

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