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China Sell-Off Continues Despite Action

China Sell-Off Continues Despite Action

China's top share index fell further on Tuesday, by 1.7%, despite renewed efforts to halt a dramatic slide in value following its second-biggest daily decline on record.

The Shanghai Composite dropped 8.5% amid widespread selling activity on Monday in response to renewed fears for the Chinese economy - raising pressure on authorities to cut interest rates further.

At one stage, the sell-off looked like it might eclipse an 8.8% decline in February 2007 when official figures showed Chinese industrial profits had fallen in June.

Wider stock markets - including the FTSE 100 - have reflected the concerns over China, with weaker commodity prices hitting the value of miners and energy firms.

On Monday, many stocks including Bank of Communications and China Life Insurance had their falls curtailed by the 10% limit down restriction, which caps the maximum daily losses for stocks with the aim of restoring stability to the market.

More than 1,700 stocks had the limit down stability measure triggered. PetroChina - the country's largest company by index weighting, narrowly escaped the limit down trigger, seeing 9.6% wiped off its value.

The fall comes just weeks after the government threatened to arrest "hostile" short sellers . Since the beginning of June the Shanghai Composite Index has lost over a third of its value.

To contain the sell-off, the government has also banned sales by large shareholders and has extended loans to brokerages in the hope that they can support the market.

China's historical market volatility is roughly three times that of the US. It's a less mature market which tends to attract short term speculators rather than long term investors, which goes some way to explaining why the government was forced to investigate short sellers.

Furthermore the lack of reliable information and transparency creates huge problems when trying to value stocks from a fundamental perspective, this means that company values are dictated by momentum driven by fear and greed rather than underlying analysis of a company's real worth.

The large chasm between the rich and the poor, and the short time frame in which certain Chinese investors have acquired vast fortunes has spawned a "get rich quick" ethos which further perpetuates the problem.

Unlike other markets, over 80% of China's stock market investors are small retail investors many of whom have been driven towards the equity markets following a clampdown by the government on excessive mortgage lending which limited the appeal of real estate investment.

Looser listing laws have liberalised the market prompting a record number of market flotations in the first half of the year.

The fanfare surrounding these launches has generated further momentum, which has led to unrealistic valuations.

Many of the growing middle classes have also borrowed on margin in order to fund their investments, with the increased leverage partly responsible for the short term volatility we have seen over the last six weeks.