Why Chinese stocks have crashed in 2018

Bobby
Yip/Reuters

• Chinese stocks have lost more than 30% of their value
  since the start of 2018.
• Fears of a slowing economy, rising debts and the impact
  of US President Donald Trump’s trade war have all played a role
  in pushing the Chinese market lower.
• However, a wave of forced selling of company shares
  could see the market drop even more.
• Hundreds of Chinese companies use their shares as
  collateral for loans, and are forced to sell when their share
  price drops below certain levels.
• Analysts believe this trend is likely to exacerbate the
  major declines already seen in Chinese markets this
  year.

Perhaps the biggest financial market story in 2018 so far is the
colossal fall from grace of the Chinese stock market, which has

witnessed losses in excess of 30% since the start of the
year.

The fall, which has seen the benchmark Shanghai Composite index
drop to its lowest level in almost four years this week, is
generally explained through the prism of investors realising that
the
blockbuster growth China has enjoyed over the last decade is on
the wane, and that things are likely to slow down to a
strong, but not stellar, rate.

Such a view has been exacerbated by
the rise of the trade conflict between the US and China,
which has seen the world’s two largest economies exchange
tit-for-tat tariffs, which now apply to goods totalling close to
a cumulative $300 billion.

Many economists see the trade war having a major negative impact
on Chinese growth, with JPMorgan earlier in October saying a
full-blown trade war could have a 1% shrinking effect on the
economy.

While these two factors are evidently at play, there’s reason to
believe that another factor could soon come into play, and force
Chinese stocks even deeper into bear market territory — forced
selling.

In China, hundreds of companies use their shares as collateral
for loans, but when share prices fall they are forced to sell in
order to maintain a certain level of balance in brokerage
accounts, used to lend the companies money.

According to 
Bloomberg
,
about 4.18 trillion yuan ($603 billion,) worth of shares have
been put up by company founders and other major investors as
collateral for loans, accounting for about 11% of the country’s
stock market capitalization, based on calculations using China
Securities Depository and Clearing Corporation data.

The South China Morning Post, citing a report
by Tianfeng Securities, said earlier in the week that

more than 600 company stocks have fallen to levels where forced
sales may kick in.

“It’s a vicious cycle: share drops lead to liquidation and
liquidation leads to further share drops,” Wang Zheng, chief
investment officer at Jingxi Investment Management told
the South China Morning Post earlier in the week.

“The recent declines, particularly in small caps, are
blamed for the problem arising from share pledges.”