Untrained retail investors at the heart of China’s market turmoil

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The state-run banks and brokerages that make up China's stock-trading "national team" are supposed to do Beijing's bidding and keep the country's markets strong and stable.

But the real Chinese national team spends its days glued to online chat groups and smartphone stock screens, with twitchy fingers that have in the past few days mashed the sell button. They are the mom-and-pop army of retail investors who account for roughly 85 per cent of trades on Chinese markets.

And if the world needed a reminder of what happens when you put too many untrained fingers on the trading triggers, it got it this week.

Thursday was by any measure an awful day for a country struggling to persuade the world its economy is not in complete tatters. A new stock market circuit-breaker slammed shut trading after just half an hour in Shanghai and Shenzhen following a sudden 7-per-cent plunge in a basket of major stocks; newly released numbers showed the country's foreign-exchange reserves fell in December by $108-billion (U.S.), a record monthly decrease that capped the first-ever year of declining Chinese reserves; and the yuan sank to a five-year low in offshore trading – all in a single day.

Cue the rush to the exits.

"Everybody wants to go into China at the same time – and everybody wants to leave China at the same time," said Steve Wang, who leads the research and investment advisory at Reorient Group, a Hong Kong brokerage. "It's just people are trying to get out."

The globe-spanning stampede is vast and complicated, as hedge-fund managers, currency specialists and oil traders from Bangkok to Frankfurt weigh everything from rising U.S. interest rates to overflowing crude-oil storage tanks and a rising belief that China's economic slowdown is more severe than once thought, and getting worse.

But at the head of the stampede is a cavalcade of largely unsophisticated Chinese investors who live in a country that has made gambling illegal but turned its stock markets into the world's largest casino. This is not a small group, numbering nearly three times the population of Canada, but they are among the most active retail traders on Earth – and they're playing roulette at a table where everyone is whispering that it's time to bet on red.

"Basically what you see is a one-way demand for people to take risk out," Mr. Wang said.

There are reasons for that bet. A pair of independent purchasing-manager-index surveys released this week showed a deepening contraction in manufacturing, and then worsening prospects in services, which Beijing has sought to turn into a new engine of growth.

The People's Bank of China, too, suddenly dropped its official yuan mid-point by 0.5 per cent Thursday, hitting its lowest level since March, 2011, and further inflaming fears that authorities are growing more worried about the economy or manipulating the currency to prop up exports – or both.

But there is risk in looking to Chinese stock markets as indicators of the country's health. "The data do not support any sudden or sharp decline of both the stock market and the FX market," said Se Yan, senior China economist with Standard Chartered Bank (Hong Kong) Ltd.

In November, still the most recent month for a slew of economic indicators, retails sales were healthy and, compared with earlier months, "investment was stronger, fiscal revenues were higher," Mr. Yan said. But "people easily panic."

Even the falling yuan isn't entirely what it looks to be. It's down against the U.S. dollar but, as the Chinese central bank pointed out Thursday, it was stable against a basket of currencies in 2015, a comparator that seems to be most important to Beijing following the yuan's crowning as a global reserve currency. (Recent days have, however, seen the yuan weaken against the yen and Euro, although it's up on the loonie).

And this week's market massacres owe at least some of their ugliness to the very measure intended to keep things in order. The circuit-breaker mechanism introduced Monday has "really exaggerated the market fall," said Changchun Hua, China economist at Nomura International, by unleashing a selling frenzy when values begin to fall. Recent days have shown that when shares drop roughly 3 per cent, the huge ranks of China's home investors race to unload stocks, in hopes they can sell before the circuit breaker shuts things down.

"Certainly China's stock market's own characteristics have played a big role here," Mr. Hua said.

Yi Ming, who works in private equity investment and has observed the country's markets since the 1990s, likened them to "a big volcano," where small underground shifts create spectacular eruptions.

"The Chinese stock market actually does not much reflect the situation in the real economy," he said. "Chinese investors are probably the most speculative investors in the world."

– with a report from Yu Mei