Ugly day for China markets: Stocks nosedive

What's happening in Chinese markets?
What's happening in Chinese markets?

It's another freakout Friday for China stocks.

China's benchmark Shanghai Composite index dropped by 7.4% on Friday, as hundreds of individual stocks lost 10%, the index's daily downward limit. The Shenzhen Composite, which is heavy on tech stocks, closed down 7.9%.

The dramatic moves could further unnerve investors, who are already reeling from last week's dismal performance by China stocks. The Shanghai Composite is now solidly in correction territory, having fallen 12% over the past five trading sessions as investors grow increasingly wary of a possible stocks bubble.

Even with recent losses, the Shanghai Composite has surged 30% this year, and the Shenzhen Composite is up 77%, easily making it the world's top-performing index.

Experts remain puzzled by the stock market boom. China's economy is going through a rough patch, with growth now at its weakest pace since 2009. Corporate profits are actually lower than a year ago.

In other words, exuberance for Chinese stocks isn't backed up by fundamentals. Instead, it appears the market is being carried higher by various forms of government stimulus and investor frenzy.

BlackRock analysts describe the market as one where "sentiment rules, while valuation is an afterthought."

"The value of turnover in China's domestic equity markets has more than doubled in 2015, and now often exceeds that of U.S. markets," BlackRock analysts wrote recently. "There are warning signs the ... market has become overheated."

shanghai stocks

In recent years, people in China -- who tend to save significantly more than their Western counterparts -- sunk their excess savings into the real estate market. Now that the housing market has cooled, investors are turning to stocks.

The market's performance set off something of a stocks mania. According to BlackRock, brokers opened four million new accounts in a single week in April.

Of particular concern is an explosion in margin buying -- the practice of buying stocks with borrowed money. Margin debt recently reached a record 8% of the market's free float, according to Macquarie.

"Old Asia hands know this pattern often ends in tears," the BlackRock analysts said.

Who gets burned when China's stock bubble bursts?

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