- 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."
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