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China market slump not seen as warning signal

International investors have been unnerved by the recent plunge in China's stock market, fearing it signaled that a global recovery may be stalling, but many analysts say those worries are overblown.
/ Source: The Associated Press

International investors have been unnerved by the recent plunge in China's stock market, fearing it signaled that a global recovery may be stalling, but many analysts say those worries are overblown.

The Shanghai market rallied a stunning 90 percent through early August, driven by what many analysts believe is a flood of money diverted into stocks from bank lending to support Beijing's massive stimulus spending. That added to hopes abroad that China would help lift the world from its economic slump.

So when the benchmark Shanghai Composite Index tumbled as much as 20 percent over the last three weeks, investors took notice, driving down the price of commodities such as copper and soybeans and stock markets around the world.

The worry was that if investors in China — the strongest major economy through the slowdown — were dumping shares and losing confidence, then prospects for other markets and economies were dim.

Among investors in the U.S. and Europe, "there's a growing belief that the Chinese stock market is a barometer of global growth," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago.

But those worries may be misguided. For one, falling Chinese stocks could simply mark a correction of a market that may have gotten ahead of the economy.

"China needs to come down, but don't read too much into it," said Ablin. "It's not an indictment of the global economy, but an indictment of investors that piled in too fast."

More important, China's 19-year-old stock market is dominated by the communist government and reacts more strongly to policy changes than to economic fundamentals. Stock prices often are disconnected from the economy's prospects.

"Historically, when the Chinese economy was doing well, the stock market could be bearish, and vice versa," said Lu Zhengwei, senior economist for Industrial Bank in Shanghai.

The major reason behind the market's drop this time was growing speculation that Beijing might tighten credit after bank lending soared in the first half of the year. That might cut the flow of money into the market that investors believe is holding up prices.

The Shanghai index plunged 5.8 percent on Monday and 4.3 percent more on Wednesday, before rebounding 4.5 percent Thursday and another 1.7 percent on Friday to 2,960.77.

China's economic outlook, meanwhile, is fairly promising. Experts say consumer spending and investment should keep growing, and Chinese banks are healthy. Helped by Beijing's 4 trillion yuan ($586 billion) stimulus spending, growth in the second quarter accelerated to 7.9 percent from the previous quarter's 6.1 percent.

The market's recent plunge "won't have any impact on the 'real' economy," said Zuo Xiaolei, the chief economist for Galaxy Securities Ltd. in Beijing. "The economic fundamentals have not changed. It's just that the stock market overreacted to the recovery message and has risen too rapidly."

Also, despite the growing attention they attract, China's markets are largely walled-off from the rest of the world. Foreigners are barred from buying the main class of shares, which are limited primarily to domestic investors, many of whom are quite new to trading on the market, and the ups and downs that can bring.

China's first stock market opened only in 1990, but the public has taken to stock trading with gusto in a system that offers few other investment opportunities.

The market has ridden a boom-and-bust roller coaster over the past decade, suffering crashes in 1999 and again in 2007.

At its highest point this year on Aug. 4, the Shanghai Composite was still down about 45 percent from its all-time peak above 6,100 in October 2007.

Small investors, many of them new to stock trading, have lost plenty of money.

"I used to have money to buy a two-bedroom apartment, but now I can only afford a toilet," a customer at a Beijing brokerage said Thursday. The 59-year-old laid-off autoworker would give only his surname, Zhang.

"I have most of my money in the market, and now I feel so sad, I want to cry," Zhang said as he stood with 20 people watching share prices on computer monitors. "We all know the economy is reviving, and the government said they will protect small investors, but actually our interests have been hurt most."

Stock prices took off after state banks pumped up credit under orders to support the stimulus. Banks are barred from lending to finance speculation in hopes of protecting them if markets crash. But economists say despite that, borrowers improperly diverted at least 15 percent of first-half lending, or 1 trillion yuan ($145 billion), and possibly double that amount into stocks and real estate.

The decline might have been sparked by a warning that the government will audit companies to catch such misconduct, analysts say. That might have prompted them to clean up their books by pulling their money out of the market.

"It's highly possible that the decline was caused by companies that have been improperly using bank lending and stimulus spending to speculate in the stock market and now pulled back," said Sun Fanghong, chief researcher for Pingan Securities. "But it's hard to say how many did this since we didn't know how much has entered the market in the first place."

Small investors are counting on Beijing to prop up prices because it wants to maintain public confidence. But many in 2007 expected similar support ahead of the 2008 Beijing Olympics — and stocks plunged anyway.

"I hope the government can live up to its words and not cheat investors," said Zhang, the former autoworker. "They should try to stabilize the market, as well as people's hearts."

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AP Business Writer Stevenson Jacobs in New York and AP researchers Bonnie Cao and Xi Yue in Beijing contributed to this report.