This year, China’s stock market reached new highs. The Shanghai Composite was up about 60% since the beginning of the year, and the Shenzhen Composite increased in value by 120% this year. On Friday, Chinese investors witnessed the stock market’s worst plunge in years.
The Shanghai composite index crashed 7.4%; the Shenzhen composite dropped slightly more - 7.9%. Share prices in Hong Kong, which are regulated separately, followed the bearish signals, and dropped 1.8%. It seems that the bubble of China’s stock market may be bursting.
There are several assumptions regarding the sudden selloff. Some investors explain that many of those who have been using borrowed money to buy stock are borrowing less and using less of the debt they have for that purpose. Margin debt on the Shanghai stock exchange fell four days straight, and now stands on 1.42 trillion yuan, equivalent to $229 billion. This is major sign that investor confidence in the market is weakening.
Another reason for the selloff is the fear from the possibility that gains generated this year might not be sustainable due to the market’s bullish trend this year.
China’s market has been seen as an anomaly. The economy in the country has been sluggish as growth has been slowing and new ventures struggled. Usually, an economic slowdown is a bad sign for the stock market, and yet many of the large public companies have seen their shares trading at 90 or sometimes 100 times of their projected earnings.
The boom in China’s economy over the last few years made few Chinese companies confident enough to try their luck with American investors, and were listed on either NASDAQ or the NYSE. In past few months however, several Chinese companies announced that they are planning to delist from American exchanges. The companies include Wuxi Pharma Tech (NYSE: WX), HomeInn Hotels (NASDAQ: HMIN) and Qihoo 360 (NYSE: QIHU). The plans to delist indicate once again that trouble might be ahead.
Many analysts have been warning of the risk associated with the Chinese stock market bullish trend this year, and that the bubble might start bursting any day on any signs of global economic insatiability. The same is true about American stock market, where the risk of a selloff in the market also exists because the market is trading near all times highs, and investors also have been buying stock on a margin.