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Two months ago I discussed in this post the effects of regulation on the stock markets in China. My theory: After the precedent China’s regulators set in April by offering two investor-friendly policies timed to pump up the markets, China’s investors would now get in the habit of looking to the government for a bailout whenever the markets were in trouble.

At the time, I predicted that the existing market fundamentals affecting China (high inflation, decreasing exports, high oil price etc) would eventually re-register with investors, and we might see another dead cat bounce. Well, the cat is back:

The above chart shows China’s CSI 300 Index, the measure of both the Shanghai and Shenzhen stock exchanges.

Two periods to take note of: First, April 20 to 24, when the two regulatory actions were announced, a clear jump in the markets was evident. Overjoyed would be an apt description of investors when their stamp duty was reduced.

Second, May 12 to 19, the week following the Sichuan earthquake, there was market confusion until May 20. Thereafter indexes began their slide over uncertain earnings growth and worries about the 8.5 percent April inflation figure, announced just before the earthquake, started to sink in.

So, what now?

The China Securities Regulatory Commission faces a dilemma: Does it toss the market a bone, perhaps by offering investors margin trading as some are predicting? Or will it finally let modern investors learn a hard lesson in stock market bubbles? As of June 11, the markets are setting new 2008 lows and volumes are dramatically down as investors start waiting for the bailout.

While I am in favor of China’s use of industrial policy to grow the economy, my admiration doesn’t extend to such shallow tactics as propping up the stock markets. Margin trading, suddenly thurst upon the investing public at such an uncertain ecomomic time, would be an unmitigated disaster in my opinion. China’s development needs to be sustainable, so supporting the pusuit of easy money is not one of the solutions China’s leaders should be considering.

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About the author

Jason Inch

1 Comment for Dead cat signals more China stock market regulation?

Schmiegel

And here most people were saying for the past two years that the government would not let the people suffer any financial setbacks by way of stock markets drops until at least _after_ the Olympics was over. Guess most pundits were wrong. Psychological rationalization can go either way!

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