China is home to the world’s second biggest stock market. This market, which peaked with a value of above $10 trillion, has been on a tumultuous ride in 2015. The market was up over 150% until June, when it suddenly crashed. The largest market in China, the Shanghai market, lost 32% in a four week slide that bottomed out on July 8. The smaller Shenzhen market slid 40% over the same time period. Immediately following this prodigious selloff, the market proceeded to have its strongest two-day rise since the 2008 global crisis. This summer’s stock market madness in China has left onlookers with many questions; principally, what caused this historic volatility and what is next for the markets?

One of the main causes of the selloff is believed to be the borrowing of money to invest in the markets. During the bull market in the first half of 2015, investors borrowed huge sums of money in order to get in on the lucrative market. Then in June, with the market at record high levels, these investors were forced to sell off all or some of their shares in order to repay their loans.

With this drastic selloff, how was the market able to not only stop its decline, but have its greatest 2 day rise since 2008? The answer to this question is a combination of both government involvement and a set of unique rules that governs Chinese stock exchanges. The Chinese government unleashed 5 trillion yuan in funds in order to calm the selloff and restore confidence in investors. To put this figure in perspective, the Chinese government only committed 4 trillion yuan in response to the financial crisis of 2008. The government also enforced various restrictions on the market, including a ban on IPO’s and a measure preventing shareholders with over a 5% stake in a company from selling their shares for at least six months. Commenting on this government intervention, Timothy Atwill, head of investment strategy at Parametric, stated that “In my experience, this was the most brazen act of a government to interfere in its equity markets.”

As far as the unique set of rules go, share prices of a stock are prevented from moving freely once they rise or fall by 10% in a day. Chinese companies are also allowed to apply for trading halts ahead of “major news that might cause a drastic price fluctuation”. This is a rule that hundreds of publically traded companies took advantage of, citing reasons such as “major event discussion” and “asset restructuring”.  According to analysis by The Wall Street Journal, on the day after the market hit bottom, a combination of these rules allowed only 3.2% of the 2,879 public companies to trade freely.

What is next for the Chinese market? That is the trillion dollar question that every broker, analysts, and manager from New York to Shanghai is trying to solve. Some analysts are predicting that this market turmoil is only the tip of the iceberg. These analysts believe that there are deep problems in the Chinese economy, namely that the economy is primarily driven by business investment and that business investment will be forced to slow due to excess capacity. These same analysts also point to the government rescue as doing nothing to help solve these underlying problems. This negative viewpoint is best summed up by Yang Weixiao, an analyst at Founder Securities in Beijing, who said that, “The problem is, all these measures only change the supply-demand relationship, without changing the fundamentals. So there's no real support, and the calm could be only temporary. If the governments exits the bailout, prices could accelerate their journey back to fundamentals."

David Zervos, chief strategist at Jeffries has a more optimistic viewpoint on the Chinese market.  In an interview with CNBC he said that investors should expect the Chinese market to experience “growing pains”, as it increases in size. He was quoted saying, “At the end of the day, in 10 years, they're going to be a $20 trillion economy and they're not going to have a $4 trillion stock market.” Zervos was referring to the capitalization of the Shenzhen Stock Exchange, and asserting that the market will undoubtedly grow in size with the rest of the nation’s economy.

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