Stock markets hit by China’s faulty circuit breaker

China’s attempts to reduce volatility have been blamed for the recent retreat from the country’s equity market.

The so-called circuit breaker was suspended yesterday afternoon (7 January) after the mechanism paused trading for 15 minutes after the CSI300 index fell 5 per cent in the first 13 minutes of trading.

When trading resumed the index fell further to 7.2 per cent, triggering the day’s halt after the shortest trading session ever at just 29 minutes.

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David Gaud, senior fund manager and global investment specialist at Edmond de Rothschild Asset Management, said the mechanism is a big shock to traditional Chinese investor behaviour.

He said: “The introduction of this new circuit breaker rule last Monday goes some way to explaining the confusion and steep fall on Chinese markets since the beginning of the year but it is not the only factor at play.

“When the market is suspended after a 5 per cent fall, the risk it might continue and drop 7 per cent drives nervous investors to step up selling to get out at any price before it hits that level. This creates a snowball effect.

“Yesterday’s confusing atmosphere is also down to various regulatory bodies being clumsy, uncoordinated and poor communicators. However, this clumsy deployment of particular measures has overshadowed the fact that China is actually adopting international standards.”

The FTSE 100 fell by 2 per cent after further turmoil in Chinese equity markets, with resources companies being the hardest hit.

On 24 August the Shanghai Composite plummeted 8.5 per cent on what became known as Black Monday.

Ian Kernohan, economist at Royal London Asset Management, said the day’s events would mean a return of talk about China exporting deflation and the idea that “they don’t know what they are doing”.

He said: “It is likely The People’s Bank of China intends to keep the Yuan stable against the basket, but allow it to fall against a rising US dollar in a Fed hiking environment.

“With the economic data likely to be more difficult to read during the first quarter, thanks to China’s New Year holiday, greater clarity on currency policy will be needed to calm market.”

Justin Oliver, deputy chief investment officer at Canaccord Genuity Wealth Management, agreed the root cause of the pull-back was China’s circuit breakers.

He said: “While the Chinese Renminbi’s continued depreciation is also in focus, it should be considered that, by some measures, it remains significantly over-valued.

“A gradual weakening will provide some much needed relief to the nation’s export sector.”

Dominic Rossi, global chief investment officer for equities at Fidelity International, said: “A lower yuan will further deflate the demand for commodities and traded goods generally. A further downside adjustment to potential world output is now unavoidable.”

Jason Hollands, managing director for business development and communications at Tilney Bestinvest, said: “China’s share of global exports has never been higher at a time of declining world trade but it has sustained levels of capacity with companies simply discounting prices rather than allow a normal, healthy default cycle, meaning there is a real risk that it could choose to allow a significant devaluation of its currency to boost its export competitiveness and dump this capacity around the globe.