News analysis

Trapped in the China stock rout

Millions of retail investors would rather hold losing positions than take a loss

SHANGHAI • Government clerk Mrs Zhu is just the type of investor the Chinese government should worry about as it tries to engineer a turnaround in the country's beleaguered stock markets, whose massive swings have heightened fears for China's financial health.

"I will sell all my shares tomorrow if there is a chance," she said.

Mrs Zhu is just one of the millions of retail investors trapped by the market crash last month, who prefer to hold losing positions rather than take a loss. She is waiting for indexes to rise so she can sell, but she is holding on because she is still set to take a loss.

The Shanghai Composite Index has shed 11 per cent since Friday. It closed 1.7 per cent lower at 3,662.81 yesterday, which is nearly 30 per cent down since mid-June's high.

Mrs Zhu's way of thinking is described as tao lao. Commonly used to mean "trapped in the stock market", it implies that an investor cannot sell out of a losing position.

The logic is also the opposite of what wealth managers typically advise: It is better to take a loss and move the money into something likely to produce stronger returns.

This highlights the risk Beijing faces in sustaining a market turnaround. Every time the government succeeds in pushing up share prices, an army of retail investors jump in to sell at their break-even point, immediately knocking back market confidence.

Given that retail investors conduct an estimated 80 per cent of trades, the government could face a long, hard grind before it stabilises markets.

Chinese stocks more than doubled in the six months to May before crashing last month by more than a third, prompting a flurry of government-inspired measures, including share buying, to stabilise prices. That calmed markets for most of this month, before a sudden drop of more than 8 per cent on Monday - the biggest one-day fall since 2007.

"Monday's plunge showed the Chinese authorities that even governmental measures have their limits. It's anybody's guess what else they can do to shore up market sentiment," said market strategist Bernard Aw from financial spread-betting firm IG.

A few more days like Monday and the damage to household balance sheets could take a heavy toll on the economy, the Financial Times said.

While investors who bought before mid-March are still in the black thanks to previous gains, a Reuters analysis of public data shows another 10 million investors opened new accounts since April, helping to push up China's market capitalisation by a net US$4.5 trillion (S$6.1 trillion) - until the bottom fell out last month.

The figures do not include existing investors who added to their positions during this time, nor the famously stubborn holdouts who are sticking to loss-making positions that are years old.

One is Mrs Xu, who is holding on to shares in China Life Insurance since 2007, when it traded for about 75 yuan per share. It is now priced at about 28 yuan and she is still holding on. "I thought I might be able to take the losses back riding on this round of bull market, but it is still losing money so far."

Both Mrs Zhu and Mrs Xu declined to give their full names.

To be sure, one upside for Chinese regulators is that the tao lao mentality can slow selling in a falling market, explaining why there was so little popular outcry last month when nearly 40 per cent of listed companies halted trading so they could ride out the crash.

It could also explain why the government set a semi-official recovery target of 4,500 points for the Shanghai Composite Exchange, which would encourage investors who think this way to wait.

But, there is no way to tell in advance how much the authorities must buy to stabilise share prices. Investor confidence premised wholly on state support vanishes as soon as the government stops buying, said.

For Beijing, however, the biggest worry is that the once patient investors are now so rattled by the swings that they are ready to accept losses just for peace of mind. "I lost 320,000 yuan (S$71,580) in two days," said student Liu Fangrui. "I don't have confidence on the market any more. I don't want to get into the market again," he told Reuters.

A version of this article appeared in the print edition of The Straits Times on July 29, 2015, with the headline 'Trapped in the China stock rout'. Print Edition | Subscribe