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Is the selloff in China cause to worry?

July 8, 2015 - macro
Is the selloff in China cause to worry?

According to NYT probably not. Call it more of a re-balancing. Market went up 83% in the last year and fell 26% last month. Fair trade.

The sharp rise of Chinese middle-class, rapid revenue growth, and less mature market led to inflated valuations and high volatility. See chart below on PE ratio comparison between Shanghai Composite (dark purple) and S&P 500 (light purple). Shanghai’s PE peaked over 25 earlier in 2015 vs S&P’s 15-17 historical range.

chinese-pe-ratio-2015Chinese government announced a number of measures to contain the selloff (interest rate cuts, prop up the market, investigate those betting on market drop) but in the end this is a supply and demand question. There just aren’t enough buyers at that level.

Add to the fact that Chinese economy is not growing as fast and fear starts to creep in. See chart below.

china-growth-2015

High valuations relative to earnings and a slower growing economy will cause a market to return to its averages. How much pain will it cause in the meantime remains to be seen.

Source: How to Make Sense of China’s Plummeting Stock Market – The New York Times