In a finance conference on this past Saturday, I had the opportunity to hear Joan Zheng, Managing Director and Head of China Research and Strategy at Merrill Lynch and former Chief Economist for Greater China at JP Morgan, explain what really happened in the Chinese stock markets on Feb 27.
Essentially, the sharp sell-off was largely technical. For a while, the Shanghai Stock Exchange Composite Index had been testing the psychological new high of 3000. Finally, when the index reached that level, many speculators decided to take profit. The rumor that the government would clamp down the speculative force in the stock markets gave traders the perfect excuse to sell. The Chinese traders were very puzzled why their action triggered huge sell-offs elsewhere in the world, especially in the U.S.
I think that the reason was quite simple. For a long while, most money managers in the U.S. were expecting a significant pull-back or correction after the markets ran up in a straight line since last July. They had been waiting for a perfect excuse to push the sell button and they got it, although the Chinese financial markets have no historic correlation with the world markets because they were close to foreign investors.
The fundamentals in the Chinese economy have not changed. Like other technical sell-offs with no fundamental changes, once traders take profit and people on the sideline pile in for bargains. In less than a month, the SSE Composite Index broke out from the 3000 level, reaching 3300.
Although the S&P index attempts to follow the recover path, the fundamentals in the U.S. are rather different. The downside risk remains significant.