Why the start of the year has been so brutal for China's stock market

An investor checks his stocks value at a stock exchange market in Shanghai.

Nir Elias/Reuters

• China's stock markets have chalked up over $6 trillion in losses since 2021.
• The market meltdown reflects a loss in investor confidence and questions over Beijing's will to stimulate the economy.
•  A relatively new derivative product called "snowballs" is adding to a vicious cycle of selling.

China's stock markets are in meltdown mode, chalking up over $6 trillion in losses since 2021 with no let-up in this new year.

The market rout is a stark contrast to some analysts' upbeat expectations of a bull run after China lifted its draconian COVID-19 containment measures. Instead, investors are now bleeding just a month ahead of Chinese New Year festivities, which will start on February 10 this year.

But how did China's markets — which were once an investor portfolio must-have — come to this?

There are fundamental concerns about China's economy and Beijing's will to prop it up

To be sure, investors everywhere were on edge going into 2023 amid concerns over an economic slowdown and US interest-rate trends feeding into market uncertainty.

But China lifted its widespread pandemic lockdowns later than other major economies, prompting expectations of a major comeback story.

More than a year on, China's economy is still trying to stage a convincing recovery and is facing significant headwinds from a property crisis, deflationary pressure, and a demographic crisis.

It doesn't help that Chinese leader Xi Jinping's regime has been cracking down on private enterprise and placing politics above all, calling into question his administration's will to support the economy decisively.

After all, Beijing has been hesitant to implement aggressive stimulus measures due to concerns over high debt levels and financial risks. This disappointed investors, who are also getting confused by confounding signals sent by authorities when they adjust policy positions.

In short, China's market meltdown, at least in part, reflects an "unprecedented confidence deficit in the economy," Vishnu Varathan, Asia economist, excluding Japan, at Mizuho Bank, wrote in a note on Tuesday.

Foreign investors are so unenthusiastic about China that they have pulled out nearly 90% of the money they put into Chinese stocks in 2023, according to a Financial Times analysis of data from Hong Kong's Stock Connect last month.

'Snowball' derivatives are creating a vicious cycle of selling 

As the market sold off over the last few years, there's also a more technical reason why China's stock markets are bleeding so much: "snowball" derivatives.

A little-known, relatively new financial product, snowballs are instruments linked to stock indexes. A decline in indexes below certain set levels automatically triggers brokerages to sell futures positions, further pressuring the market.

This domino effect echoes what happened in 2015 — the last time China's stock markets appeared to be in free fall. 

At the time, Chinese investors were forced to sell stock holdings which they borrowed money to invest in, because they could no longer top up cash or assets to their account during a "margin call" — further pressuring the markets.

Beijing is trying to soothe nerves, but investors may not hold out

Beijing appears to be concerned about the market meltdown and is trying to shore up confidence.

China's securities regulator implicitly instructed some hedge fund managers to restrict short selling, Reuters reported on Wednesday, citing unnamed sources.

On Tuesday, Bloomberg reported that Beijing is considering a 2 trillion Chinese yuan, or $282 billion, package to stabilize the market.

Premier Li Qiang has also instructed authorities to take more "forceful and effective" measures to stabilize the markets and investor confidence, according to an official statement on Monday. There were no further details.

Hong Kong and Chinese markets appear to be somewhat buoyed news of Beijing damage-control measures, with the Hang Seng Index rallying 3.6% Wednesday, cutting year-to-date gains to about 7%. Meanwhile, the CSI 300 — which tracks 300 Shanghai and Shenzhen-listed stocks with the largest market capitalizations — was 1.4% higher, but was still 4.5% lower so far this year.

"In our view, if the Chinese support funds are indeed mobilized, we will get a short-term positive impact that will help to arrest the downward momentum, but it may be difficult to mobilize the entirety of the proposed 2 trillion Chinese yuan target," wrote ING economists in a note on Wednesday.

"Furthermore, for a more sustainable rally, we likely need to see further clarity on potential stimulus policies to be released later in the year. Sentiment remains fragile for now," they added.

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