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Will Chinese Stock Decline Impact U.S. Earnings?

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China Stocks

Will Chinese Stock Decline Impact U.S. Earnings?

July 29 2015, 07.36am GMT


The decline in China’s stock markets should have little direct impact on U.S. markets, while the indirect or knock-on effect could have more impact.

The important factor to examine here is the actual impact the market slump in China will have on the wider Chinese economy and ultimately, on the economies of China’s trading partners.

Public participation in the markets in China is, to a large degree, not an investment exercise, but rather a legal form of gambling. 

Bill Stone, chief investment strategist at PNC Asset Management Group, said, “We believe China’s stock markets has less connection to the real economy than even the U.S. market since most Chinese market participants keep the majority of their wealth elsewhere and view the stock market more like a casino.”

An analysis by Knowledge@Wharton asserts that the rollercoaster ride of Chinese stock markets over the past year reveals the snowballing effect of the actions of disparate players. The Shanghai Composite index soared by 150% during the past year and then lost 30% in three weeks. None of this fluctuation seems in any way related to the actual underlying performance of the listed companies or their values.

When the market was rising, investment was led by state owned enterprises (SOEs) governed by a desire to command high valuations for Chinese stocks. Higher stock prices would then help the SOEs who could resell the stock for higher values and repay loans to help cut their debt levels. The government, at the same time, made it easier for investors to borrow funds which increased demand with the resultant upward pressure on prices.

This action in many ways smacks of market manipulation at state level in the interests of the financial advantage of the SOEs.

Wharton Emeritus management professor Marshall Meyer said that, “the theory that the market was pumped up to help SOEs to reduce their debt is plausible.” Meyer added, “Someone has called this the world’s biggest debt-to-equity swap. The government hoped that it could manage the market upward and use the market mechanisms to relieve some of the debt of the SOEs and everybody will be happy. But it went out of control.”

The size of the Chinese economy and the growing demand for U.S. goods means however, that an extended period of market volatility could affect the performance of companies such as Apple (AAPL, +o.05%) and Qualcomm (QCOM, +1.81%) who see China as an important export market.

An important factor putting downward pressure on Apple stocks after its Q2 report is the fear of a drop in demand for their iPhone on the back of a falloff in the Chinese economy.

Meanwhile, J.P. Morgan’s advice is to stay away from mainland Chinese markets and to rather look to the more stable Hong Kong Stock Exchange which is not subject to the same government pressure as markets such as the Shanghai Stock Exchange and other markets based on the mainland.

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