What you can learn from the Chinese stock market crisis

By Randell Tiongson on July 20th, 2015

While the world had its eyes on Greece and the Eurozone, something big was happening closer to our doorstep — a 30% drop in the Shanghai Composite Index in the span of just three weeks. Hundreds of companies stopped trading, and the Chinese government brought the hammer down to try to stop the skid, even threatening to arrest people who short sell. Many analysts think that these actions may have just made things worse.

china economy

(Photo from HERE)

The Chinese stock market, before this drop, had been having a ridiculously good run, soaring on the wings of individual investors. These small investors started buying a lot of stocks over the last year with borrowed money (also known as margin financing), encouraged by the government to invest in the stock market. Because of this borrowing, more than 80% of Chinese investors are small-time individuals; in most other markets, investors are mostly institutes. The influx into the stock market sent valuations skyrocketing. The Shanghai index increased over the last three years without matching the growth rate of the Chinese economy.

But what goes up must come down, and that’s exactly what happened. Because the growth was being driven by momentum and not fundamentals, people began to fear that it was unsustainable, and began to sell, triggering the steep drop in stock prices. In the long term, the real value of these stocks will be and should be reflected by the market.

So what does this mean for the regular Filipino? At the moment, the Chinese economy’s downturn won’t have lasting effects on us for the short term. The companies listed in the Chinese stock markets are not directly connected to the Philippine economy. This means that ordinary Chinese are taking most of the impact of the crash.

And even after the stock market plunge, China’s economy is still growing at the predicted pace. They already released their second quarter 2015 growth at 7% — although there are questions about the validity of this figure.

However, it’s the threat of a slowed-down Chinese economy that would be a problem for us. If China’s growth falls below 7%, that could affect many of manufacturers in ASEAN including the Philippines — since our region provides a portion of the intermediate goods for China to finish or complete.

There are a few lessons you as an individual investor (or one trying to be) can take from the Chinese stock market crash, though:

1. Don’t sell in a panic. A lot of people’s first instinct, when faced with a crash, is to sell, which just makes the crash worse. Don’t panic; always have an eye on the medium- to long-term. With the strong fundamentals of the Philippine economy, more likely than not any dip caused by panic about the Chinese stock market will ease over time.

2. Focus on the internal strength of the economy. Many of the infrastructure projects are limited to local blue chip firms. They should be setting the stage for future returns once these projects go online. Hopefully these projects funnel and facilitate the movement of income from these big firms to the smaller ones.

3. Don’t borrow money to invest. I would recommend that you only invest money you already have and won’t need in the medium- to long-term instead of getting margin loans to make investments. When you buy stocks with borrowed money, you can’t afford to ride out a crash by holding on to your stocks until prices climb back up; you have to sell what you can so you can pay back your lender. And if the market has fallen by a lot, you might lose all your money and can’t repay your debt. Only invest what you can afford to lose.

All these economic crises hitting at once may make you worry about your own investments. But the Philippines, despite being exposed to China’s volatility, is still targeting 7 – 8% growth, according to Economic Planning Secretary Arsenio Balisacan. We still don’t know how we’ll be ultimately affected by what’s happening in China right now, but the effects should be manageable in general.

If you’re an investor, remember to stick to your investment timeline and long-term goals, and keep an eye on the China story as it develops over the next few weeks and months but do not be in fear.

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3 thoughts on “What you can learn from the Chinese stock market crisis”

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What you can learn from the Chinese stock market crisis