China's 30% Plunge: A Sign of Things to Come?

High-speed trains have played a role in China's infrastructure boom. Image source: Alex Needham via Wikimedia Commons.

In the U.S., the recent correction has been relatively mild, with most major stock market benchmarks remaining down around 10% from their recent highs. For China, however, the magnitude of the ups and downs in the stock market has been a lot more extreme, and as Chinese stock markets finished the third quarter overnight on Wednesday, investors there have had to deal with the worst returns since 2008's financial crisis.

Despite a gain of around half a percent today, the Shanghai Composite (NYSEINDEX: ^SSEC) closed the quarter down almost 30%, and other indexes of Chinese stocks saw similar performance. Off the mainland, Hong Kong's Hang Seng Index completed the quarter down more than 20%, reflecting both its own local concerns and the broader difficulties that the regional economy is facing. The question going forward is whether China's stock market has already seen the worst of its losses or whether more declines are yet to come.

China takes actionChina hasn't been blind to the problems facing its economy and the impact that they've had on its stock market. Some market commentators attributed part of today's bounce to a move from the Chinese government to slash by half the sales taxes that car buyers pay on small vehicles. That supports automakers in China, which along with the rest of the industrial sector has seen a big slump in profits despite reduced costs for many of the commodities they use as raw materials for production.

In addition, the Chinese government has focused on major infrastructure projects to try to bolster key segments of the economy. For instance, the nation has made great strides in building up its domestic rail network, providing more links between different parts of the country, and it is now working at extending its reach beyond its own borders to serve parts of Southeastern and Central Asia.

Nevertheless, most economists have argued that China needs to move beyond a government-led economic system in order to thrive. Structural issues that have pushed property values to extraordinary heights in some areas could threaten to topple the real estate market and could spill over into other parts of the economy. Promises that China would be able to transform itself into a consumer-led economy that would focus less on manufacturing exports and more on serving growing internal demand for goods and services haven't panned out as quickly as many had hoped.

Meanwhile, Hong Kong has its own issues to deal with. Its long-held currency peg to the U.S. dollar has left the territory reliant in large part on American policy, and so expectations that the Federal Reserve will raise rates in the near future come at a tough time. With ongoing reliance on the health of the Chinese economy but with exposure to the rest of the globe, Hong Kong in some ways has the worst of both worlds at the moment.

Even though the declines in China's stock markets have pushed the Shanghai Composite to its lowest levels of the year, investors need to remember that the key benchmark is still 50% higher than it was less than a year and a half ago. With so much volatility, it's easily conceivable that further declines could come before China puts in a lasting recovery.

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