Beijing Encouraged a Stock Rally in 2015 and Then Could Not Stop It
State media promoted equity ownership, retail investors borrowed to participate, and the resulting rise reversed violently. The intervention that followed was extraordinary in scale.
The Build Up
Through late 2014 and the first half of 2015, Chinese domestic equity indices rose dramatically. The move was not driven primarily by earnings.
Official commentary encouraged participation, presenting a rising market as a sign of national economic confidence and as a route to shift corporate financing away from bank debt toward equity. State media coverage was supportive.
Retail investors responded at enormous scale. New brokerage account openings ran at extraordinary levels, and a large proportion of the new participants had limited market experience.
Margin Was the Accelerant
The critical feature was borrowed money. Formal margin lending through brokers expanded rapidly, and an additional layer of informal lending through trust products and grey market channels operated outside the regulated system, at higher leverage.
Leverage does not simply amplify a rally. It converts a decline into forced selling, because falling prices trigger margin calls that require sales regardless of what anyone thinks the assets are worth.
The size of the informal lending was, by its nature, poorly measured. That uncertainty mattered later, because nobody could reliably estimate how much forced selling was still to come.
The Reversal
From June 2015 the market fell sharply. Regulatory efforts to restrain margin lending, always a difficult exercise once positions are established, coincided with the turn.
The decline then became self reinforcing. Margin calls forced sales, sales pushed prices lower, lower prices triggered further calls. Investors who had borrowed most were liquidated first and their selling accelerated the move.
Within roughly three months the main indices had fallen by around 40 percent from their peak.
The Response
| Measure | Effect |
|---|---|
| Trading suspensions by companies | A large share of listings stopped trading |
| Ban on selling by large shareholders | Removed a category of seller |
| State backed buying | Direct purchase of shares |
| Suspension of new listings | Removed competing supply |
| Investigations into short selling | Discouraged bearish positioning |
The trading suspensions were the most striking. At the peak of the episode a very large proportion of listed companies had halted trading in their own shares, which meant investors needing liquidity could only sell whatever remained open. That concentrated selling pressure onto the stocks that had not suspended.
A circuit breaker mechanism introduced in early 2016 made matters worse and was withdrawn within days. The thresholds were set close enough together that hitting the first one caused investors to rush to sell before the second triggered a full halt, which is the opposite of the intended effect.
What It Demonstrated
Three things, each of which generalises well beyond China.
Official encouragement of a market creates an implicit expectation of official support, and that expectation increases the pressure to intervene when the market falls.
Leverage in the hands of inexperienced participants makes a decline mechanical rather than sentiment driven. There is no price at which a forced seller stops selling.
And suspending trading does not remove selling pressure. It relocates it, either onto other securities or into the future.
The Consequences
The episode damaged confidence in the domestic market for years and complicated the process of including Chinese equities in global indices, since index providers require confidence that investors can actually trade.
It also shaped policy. Subsequent Chinese market interventions have been more targeted, and the enthusiasm for encouraging retail equity participation as a policy objective was noticeably tempered.
The Bottom Line
The 2015 Chinese equity episode combined official encouragement, inexperienced retail participation, and substantial hidden leverage, then reversed with the mechanical violence that leverage produces. The intervention was unprecedented in scope and demonstrated that halting trading redistributes selling rather than preventing it. The general lesson is that a state which encourages a rally acquires an obligation to defend it.