Sell Off in Chinese Stocks Sends World Stock Markets Reeling

Today was one of those days that causes people to sell all their stocks and swear off the stock market forever.  It was the worst day for the market since the re-opening after the Sept 11, 2001 terrorist attacks. 

At 3:00pm EST, due to a computer glitch (subscription required), the Dow, already down more than 200 points, suddenly lurched down more than 200 more in a matter of seconds.  At one point the Dow was down well over 500 points.  I was watching on CNBC and I could barely believe my eyes. 

At the end of the day things stood this way:

Dow: -416, to 12216

Nasdaq: -97, to 2408

S&P 500: -50, to 1399

10 Year Treasury yield: -.12%, to 4.51%

VIX: +7.16, to 18.31

Why?  The cause seems to have been a sell-off in the Chinese stock market (subscription required), the Shanghai Composite Index.  The time in Shanghia, China, where the Shanghai Stock Exchange is based, is 13 hours ahead of East Coast time and 16 hours ahead of West Coast time.  During Tuesday’s trading session in China, which took place from 5:30pm to 11:00pm PST (8:30pm to 2:00am EST) Monday evening, the Shanghai Composite Index lost almost 300 points or close to 9%. 

Nobody really seems to know why.  The most plausible explanation I’ve come across goes something like this: A couple Friday’s ago (Feb 16) the Shanghai Composite Index broke 3000 for the first time in its history before closing slightly below that significant level.  The Chinese markets were then closed all of last week for the Chinese New Year.  This Monday the index again broke above 3000 and this time closed above it as well. 

The Chinese government has been voicing alot of concerns about the overheating of the Chinese stock market recently.  There’s been talk of reducing access to margin as well as imposing a capital gains tax.  The government goes into session beginning next week.  Therefore, with the eclipse of the 3000 mark investors began to fear that the government might impose some damaging regulations when they meet next week and so they sold off to lock-in profits. 

Why this led to a sell off in US markets when they opened hours later isn’t entirely clear to me. 

A durable goods report (subscription required) came in a bit below expectations here in the US.  But that doesn’t seem to be sufficient to explain such a big drop.

For whatever reason, the US stock markets opened up lower.  The Dow traded down to around 12500, down about 150 points, almost immediately.  It wasn’t until 2:30pm EST that the Dow broke below 12400 and it started to look like this might be an unusually bad day.  Then things got really bizarre with the computer glitch at 3:00pm EST when the Dow dropped down to around 12100 before bouncing above 12200 to close at 12216. 

Here’s one possibility: for weeks on end, everybody’s been talking about how the Dow hasn’t had a down 2% day in this many consecutive trading days, the second longest streak since when or whatever.  People have been looking for a correction forever.  People have been talking about it incessantly on CNBC and in the market commentary.  So when the market sold off heavily on the Chinese stock market it was easy for that momentum to keep going as people started to think “Oh, here’s that correction everybody knew was coming”. 

The sell off in Chinese stocks doesn’t seem sufficient to explain the magnitude of the sell-off.  Combined, however, with the widespread expectation that we would see a correction in the near term, we start to have what looks like a fuller explanation.  People started to believe that this was the correction we’d all been waiting for, panicked and started to sell.  Lower prices led to more selling and we had the worst day in almost 6 years. 

The question on everybody’s mind is: is this a one day thing or the beginning of a downward trend? 

And the answer, of course, is that nobody really knows.  We’ll have to wait and see.

One encouraging sign, however, is the rebound in the Chinese market.  With about a half hour left in their trading day for Wednesday (10:37pm PST) the Chinese market has rallied and is up about 113 points, 4.09%, to 2886 (source: Shanghai Stock Exchange, https://www.sse.com.cn/sseportal/en_us/ps/home.shtml).  Not only that but, according to Yahoo!, almost all of those gains have come in the last hour and a half.  In fact, as I’ve been writing this post, the market has started to accelerate to the upside.  This bodes well for tomorrow.

Update (Wed, 9:33am PST): The Shanghai Composite Index finished up 109 points to 2881 in Wednesday’s trading.