The Chinese government intervened in their stock market on January 6 after a $600 billion drop. The People’s Bank of China injected liquidity too. Can this policy work or is it doomed?
It can probably work indirectly and possibly for a long time. Whether it works depends on whether or not people change their mind about valuing equity securities and risk. There is an important piece that keeps it from working directly.
Stocks are not money. The price of a stock is the amount of money you can trade it for at a particular moment in time. That price is set by the consolidation of all of the beliefs of all of the people who hold the stock or want to hold it. It is opinion.
How much someone wants to hold a security is a function of how they see the future. If it appears risky they will not want to hold it much so the price will fall. If a few people decide to get out the price may fall more and for some people that fall will represent risk. Fall further.
The money the government uses to support the market is real. It has value in use and it is not opinion. When you use real money to influence opinion, you are hoping the people will change their mind about value. If the underlying stock has suffered no business impairment then it should work. People will come to see that a valuable business at one price is pretty much the same business at 60% of that price. Then intervention works.
What if there has been impairment? Then the intervention will great an illusion of stability. A trick. People will be harmed if they believe an illusion. The throwing good money after bad idea.
As an investor, mistrust government intervention. Governments work for their own purposes and not necessarily for yours. In this case governments like stability because that makes it look like they actually do something useful. Better some wasted money than a revolution. Eventually though, the structural faults must appear. Then what?
You can likely determine what is happening and a time scale for it to happen, but be cautious. Understand meaning before committing. There are always other options.
The game of investing is quite different when the fundamental rules are suspended.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.