Markets vs. Market Psychology

The sharp one-day drop in the Chinese stock market on February 27 apparently had an enduring negative effect on major stock markets around the world. By the time the exchange closed at 7:00 GMT that Tuesday, the Shanghai Composite Index had fallen 8.8% for the day – the biggest one-day fall in China in ten years.

A cascade of declines in other countries immediately followed. In Singapore, the Straits Times Index was down 2.3% when the market closed. In Bombay, the Sensex 30 fell by 1.3% that day at the market’s closing. In Moscow, the RTSI index was down by 3.3% at its closing bell. In London, the FTSE 100 was off by 2.3% when trading ended that day. In Sao Paolo, the Bovespa index was down by 6.6%, and in New York the Dow Jones Industrial Average was down by 3.3%, when those markets closed at 21:00 GMT.

These were significant declines – larger one-day drops in the Dow, for example, have occurred only 35 times since January 1950, or about once every twenty months. Moreover, two weeks later, all these markets outside of China were down from 4.3% to 7.8% compared to their close on February 26.

This large and enduring effect has surprised many, since the “story” about the Chinese drop – that the trigger was a rumor that China’s government, concerned about speculation, planned to impose controls on the stock market – seems to have no logical relevance elsewhere.