Why All The Volatility In China?

So far in 2016, financial markets around the world have been buffeted by what’s occurring in China.

The mainstream financial media likes to play the situation up as if China is in dire straits. As someone who’s seen pundits proclaim the end of the Chinese economic boom for well over 20 years, I can tell you China’s economy isn’t falling off a cliff.

But there are substantial changes occurring, as this centrally planned economy allows markets to operate more freely in China.

So just what is going on there? And why is there such turmoil in China’s markets?

There are three reasons…

Reason #1: Failed Circuit Breakers

One cause of turmoil in the Chinese stock market is the failed circuit breaker experiment.

The concept was sound. After all, the world’s major stock markets all have circuit breakers in place to halt a collapse in stock prices.

But Chinese regulators – remember, this is all new to them – placed their circuit breakers in a range that was too narrow. Trading was halted for the day after only a 7% drop in prices. They should have adopted the U.S. model, which shuts down the market only after a 20% price drop.

Now the circuit breakers are gone. What remains is a halt in individual stocks after a 10% drop in price.

I wouldn’t be surprised to see China reintroduce circuit breakers at some future date, with a much wider trading band.

Reason #2: Unsophisticated Traders

Another reason for all the volatility in China’s markets is that on the mainland, most of the trading (about 85%) is still done by individual mom and pop investors. Many simply didn’t grasp the concept of circuit breakers, which was poorly explained by the regulators.

China has yet to develop a deep pool of institutional investors like in the developed markets, which would create stability.

China also doesn’t have a Warren Buffett-type figure yet. A person like him saying all is well, and that he is buying stocks, would keep flighty individual investors from panicking.