Monday, September 7, 2015

(Some concepts to b understood before we move to the topic )

What is a market bubble ?

  • bubble is a type of investing phenomenon that demonstrates the delicateness of some facets of human emotion. 
  • A bubble occurs when investors put so much demand on a stock that they drive the price beyond any accurate or rational reflection of its actual worth, which should be determined by the performance of the underlying company. 
  • Like the soap bubbles a child likes to blow, investing bubbles often appear as though they will rise forever, but since they are not formed from anything substantial, they eventually pop. 
  • And when they do, the money that was invested into them dissipates into the wind.

What is a market crash ?
  • A crash is a significant drop in the total value of a market, almost undoubtedly attributable to the popping of a bubble, creating a situation wherein the majority of investors are trying to flee the market at the same time and consequently incurring massive losses. 
  • Attempting to avoid more losses, investors during a crash are panic selling, hoping to unload their declining stocks onto other investors. 
  • This panic selling contributes to the declining market, which eventually crashes and affects everyone. Typically crashes in the stock market have been followed by a depression.

What is the relation between market bubble and market crash ?
  • The relationship between bubbles and crashes is similar to the relationship between clouds and rain. 
  • Since you can have clouds without rain but you can't have rain without clouds, bubbles are like clouds and market crashes are like the rain. 
  • Historically, a market crash has always precipitated from a bubble (pun intended), and the thicker the clouds or the bigger the bubble, the harder it rains.

What is a margin ?
  • Borrowed money that is used to purchase securities on some kind of a collateral /mortgage. This practice is referred to as "buying on margin".
  • When individual investors borrow from a broker to buy securities it is called as marginal financing.

What is a margin call ?

You would receive a margin call from a broker if one or more of the securities you had bought (with borrowed money) decreased in value past a certain point. You would be forced either to deposit more money in the account or to sell off some of your assets.

What is a market correction?
  • A correction is a decline or downward movement of a stock, or a bond, or a commodity or market index.
  • The amount of the decline is at least 10 percent and a true correction exceeds that amount.
  • In short, corrections are price declines that stop an upward trend.

Why do corrections happen?
  • Stocks, bonds, commodities, and everything else traded on the markets never move in a straight line, either up or down. At some point their value will change—for better or worse.
  • When stock or bond prices go up, it may seem like there's no end to how high they can go. When this happens, stocks or bonds become 'overbought.' That means some investors will try to buy into the rise of stock prices with the hope of making profits before a downward trend begins.
  • But as they do buy in, the investors who bought earlier—helping to push the stock or bond price up—will consider selling when they think the price is near a peak. Investors might base their thinking on an earnings report for a certain stock that shows flat profits, or a belief that a certain industry will face trouble. Any kind of 'bad' news can trigger a sell-off.
  • And sometimes, investors will simply take profits as the market heats up. In either case, the selling pressure drives prices down.

Is a correction good for the market?
  • Many investors and analysts look at corrections as a necessary 'evil' to cool off an overheated stock or bond market. This is to prevent a huge sell-off or 'bubble burst,' as what happened with Internet stocks in 2000-2001 and now in case of Chinese markets.
  • It's believed that corrections adjust stock prices to their actual value or "support levels," and so, are not overpriced or inflated.


What Happened to China’s Stock Market 

  • After climbing by 150% in the last year, China’s stock market has taken a tumultuous turn. 
  • The market has fallen by 30% over the past month, sparking worries amongst investors across the globe. (the bubble bursted)
  • The Chinese stock market crash began with the popping of the stock market bubble on 12 June 2015.
  • Hundreds of Chinese companies have suspended dealings in their shares in a bid to arrest a frenzy of selling. 
  • The authorities have stepped in with various measures, including a surprise interest rate cut. But so far, their efforts have failed to stem the rout and some analysts say the moves by officials have only served to heighten alarm.

But weren’t China’s stock markets soaring just a few weeks ago before the crisis?
  • They were. China’s stock markets had previously been among the highest performing in the world, and had hit a seven-year peak in the middle of June. The Shanghai stock market had surged more than 150% in 12 months.

What was behind the dramatic rise in shares?
  • Investors have been piling in, encouraged by falling borrowing costs as the central bank loosened monetary policy.
  • Unlike most other stock markets, where investors are mostly institutional, more than 80% of investors in China are small retail investors.
  • Laws liberalising the stock market also made it easier for funds to invest and for firms to offer shares to the public for the first time. 
  • The past six months have seen a record number of businesses listed on the Shanghai and Shenzhen exchanges.

Why did the market fell then ?
  • Analysts were already warning that the dramatic rise in China’s stock markets was driven by momentum rather than fundamentals. 
  • Stocks were looking wildly overvalued at a time when the Chinese economy was losing steam. 
  • As fears grew that the rise in many stocks was unsustainable, the selling started.

How could so many people afford to buy shares?
  • At the centre of the dramatic stock market slide are individual investors borrowing from a broker to buy securities. (marginal financing) 
  • There has been an explosion in so-called margin lending. 
  • Under that system, the broker can make a demand for more cash or other collateral if the price of the securities has fallen – known as a margin call.

What is the problem with margin calls?
  • In short, the problem for China’s 90 million or so retail investors is that shares can go down as well as up.
  • Margin calls are in no way exclusive to Chinese markets. 
  • But the mix of investors is unusual compared with most global markets. 
  • As brokerages have lapped up people’s appetite for borrowed money and stock market bets, more households have become exposed to the risk of a stock market correction
  • Regulators ( just like India has SEBI, China has Security Supervision Commission) have cracked down on margin trading in recent months and the resulting falling share prices have triggered margin calls. 
  • If those margin calls continue, investors will have to offload other assets to come up with the cash they need.

What are the Chinese authorities doing?
  • Beijing has supported a series of market operations to halt the sharp decline, but each one has been criticised for failing to restore market confidence.
  • China has arranged a curb on new share issues and enlisted brokerages and fund managers to buy massive amounts of shares, helped by China’s state-backed margin finance company, the China Securities Finance Corporation (CSFC), which in turn has a direct line of liquidity from the central bank.
  • The central bank, the People’s Bank of China, said it would continue to work with the CSFC to steady the stock market. 
  • The CSFC also said it would purchase more shares of small and medium-size listed companies – the firms that have suffered the biggest losses in the rout.

What is the economic backdrop?
  • China’s economy was already losing steam. Its GDP growth rate halved from 14% in 2007 to 7.4% last year. 
  • In a sign of softening demand, imports have been falling in recent months. Exports have also eased off, despite government measures to stimulate growth.

How did this spill into other markets including 

India ?

  • To cover margin calls, investors are having to sell other assets (in other markets) to raise money. 

Who is most exposed?
  • Asian countries have strong trade links with China, so stand to lose out if its economy is hit by stock market falls. But it has been seen it has affected globally.
  • It's being called the contagion effect, namely the concern that a China-led global slowdown could hurt economies in Asia badly - particularly commodity countries such as Indonesia and Malaysia, that have seen their economies boom because of the demand from China over the last decade.

So how does the turmoil in China compare with the crisis in Greece?
  • Potentially, the stock market rout in China, with all the political, social and economic risks it entails, could turn out to be a much bigger threat to the global economy than the debt crisis in Greece.
  • Economists have said that even if the stock market has limited impact on the real economy in China, that economy was already slowing. There is a risk, they say, that China is heading for a “hard landing”. (Definition of hard landing: When the economy goes directly from a period of expansion to a recession.)

Here's how things happened !!

  • June 12: The Chinese stock market reached a record high following government intervention efforts made throughout the months of May and June. Stock prices began to slide downward in the days following, however, and continued to drop throughout the summer.
  • July 4: The Chinese government suspended the sale of new stocks to stave off continuing losses, to little avail.
  • July 31: The Shanghai Composite closed the month with a 15 percent decline, making it the worst month for the Chinese stock market since 2009.
  • August 10: The People's Bank of China devalued the currency of the yuan by almost 2 percent in an effort to respond to a recent economic slowdown in the country. Shares in Beijing began to drop almost immediately in the days following.
  • August 18: Stock markets across Europe, in the U.S., and Australia began to see losses that would continue throughout the next four days.
  • August 21: The Dow Jones Industrial Average sunk 531 points, closing with the worst losses since 2011.
  • August 23: The Shanghai Composite plummeted 8.5 percent overnight, counting some of the worst losses in China's stock market since 2007.
  • August 24: "Black Monday" began as China's markets opened to steep losses and analysts said they feared the crash would continue to damage the New York Stock Exchange and markets worldwide.

5 ways China market meltdown can impact India.

1. Good for smart cities: Hard commodities have been hit in expectation of a Chinese slowdown. Copper is trading at a 6-year-low.  China is the world’s top copper consumer, accounting for 40% of global consumption. Similarly, aluminium is trading at new lows and is already trading at prices below cost of production of many Chinese companies. For India as a consumer, this is good news as the cost of constructing new infrastructure, especially smart cities, will come down. For producers of these metals, low prices are bad, especially so because China has resorted to aggressive selling to clear its inventory and raise cash during adversity. Little wonder metal stocks are bearing the brunt of the fall.
2.  Good for deficit and inflation management: Oil prices were already taking a beating, with global slowdown and a possible US-Iran deal, China only nudged the prices lower. For India, low oil prices helps in controlling its deficit and keeps inflation under check.
3. Bad for automobile producers: Automobile exporters and manufacturers, especially Tata Motors will feel the pinch as China was its fastest growing market, especially for JLR, and the company was investing in the market to drive future growth. But auto-ancillary suppliers will be hit as China consumption falls.
4. Gold might glitter: Chinese had overtaken India as the largest consumer of gold. Prices of gold have slipped to a four month low in expectation that the present meltdown will spill over to the gold market. But the fall in gold prices seems to be a temporary blip. China imported 36% more gold both on a year-on-year and month-on-month basis, suggesting investors are parking their money in safe havens. Gold prices may move up soon.
5. Mobiles can be cheaper: The real impact of the Chinese meltdown will be clear from the government’s action in the foreign exchange market. China has been pegging its currency against the dollar but the Yuan which also trades on the New York currency exchange hit a three month low on fears that the market meltdown will impact the economy. 
If the Chinese officials do devalue their currency to push growth, world markets will be flooded with Chinese goods at low prices affecting exports of other countries including India (and they did it ..about 4% devaluation!!! ).

The rupee factor
  • The slowdown in China is the critical factor. The steep fall in Chinese stocks and the four per cent devaluation of the yuan have sparked calls for controlled devaluation of the rupee to keep Indian exports competitive. But the link between a weak rupee and strong exports is tenuous at best. 
  • As Swaminathan Anklesaria Aiyar wrote recently in a business daily: "Some Indian analysts want steep rupee devaluation. But studies by C Rangarajan, Prachi Mishra, Sajjid Chinoy and Jehangir Aziz suggest that Indian export growth is not strongly linked to the exchange rate, and depends much more on global growth.
  • "So, steep devaluation may not revive Indian exports, given gloomy global trends. Real rupee appreciation should be avoided. But a more aggressive approach than that could simply fuel a currency race to the bottom. That is a bigger danger by far. India needs to sound alarm bells on this, and get the IMF on board to stop any currency war. Slowing Chinese growth alone may not cause a world recession. But competitive devaluation surely will."

What must INDIA do ?

  • India needs to urgently ramp up broad-based economic reforms. 
  • Key among these are land, GST, labour, administrative and tax. 
  • In the meantime, the RBI must loosen monetary policy to spur both consumer demand and corporate investment. 
  • With the global economy in turmoil, time is running out.
  • While foreign investors are pulling out of our stock markets, it is now critical to encourage more foreign direct investment which includes foreign companies interested in setting up businesses in India. 
  • While we cannot prevent the stock investors from exiting, we can certainly make India an easier place to do business through imaginative policies. 
  • We can start by reforming many bad laws that do not require Rajya Sabha approval or at least allow State governments to frame their own laws in the spirit of competitive federalism. 
  • The government can fast track clearances for mega foreign investment projects especially in infrastructure sectors. 
  • A mini-crisis can also be an opportunity to start selling off loss making public sector companies that are bleeding the exchequer. 
  • It may also be useful to introduce innovative schemes encouraging NRIs and PIOs to invest in India. 
  • Finally the government should have absolute clarity on taxation issues and not upset the already nervous foreign investors.


What are the lessons that the world should learn? 

  • It is well known that countries no longer live in isolation but are more closely linked to each other than before. 
  • Therefore there can be no excuse for not having greater international cooperation in economic policies.
  • Moreover policy makers have to realize that long term solutions to global economic challenges will not come from central banks alone. 
  • There has been too much focus on interest rate cuts, quantitative easing and lending as means of solving economic problems. 
  • There has to be coordinated efforts on improving infrastructure, productivity and quality of life across countries that will help the world to enjoy sustained economic prosperity for all.

Moral of the story ?

As for the bloodbath going on in the markets, some experts assure us that it is simply a market correction and things will settle down soon. Unfortunately only time can tell.


The Wall Street Journal

The rupee has also performed well against most Asian currencies, barring the yuan, reflecting its reduced vulnerability to external shocks.

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