Was China the Catalyst for Last Week's US Stock Market Losses?

Last week, the Dow Jones Industrial Average (DJIA) went into free fall, closing with a loss of 416.02 points, or 3.29 percent. The media gave many reasons for the dropping market, the most common of them being China and their falling market. Shanghai's market was put under the magnifying glass.

China's market lost almost 9 percent last Tuesday (February 27, 2007), which in many analysts' opinions was the catalyst for the 3.29 percent drop in the DJIA. Granted, there may have been some emotional reaction among investors not only in the US markets, but globally as well. When in reality, there should have been little spin-off between the two markets. Yes, there are some stocks that are directly correlated to the Chinese market such as Caterpillar (CAT) that provides mining and construction equipment to China. CAT fell 3.6 percent. However, there were other contributing factors.

Firstly, it is important to understand why China's market fell. According to Azam Ahmed of the Chicago Tribune, Chinese stocks fell after the government approved a special task force to clamp down on the illegal activity that had helped fuel the growth in the Chinese market. Unlike the United States, China's market success has been attributed to the individual investor. Individuals mortgaging their homes and borrowing money any way they can to make purchases on the stock market.

"This [new regulation] prompted fears that the world's fastest-growing economy could be at risk of slowing, significant given China's massive size and demand for commodities such as metals and oil," Ahmed said. Even so, the reasonable investor should expect some kind of correction in a market that has grown 130 percent since 2004.

The emotional reaction to China's dropping market created a chain reaction within the US markets that triggered investor's stop loss settings as well as computer software investing systems to begin selling when the market began its fall.

There is much more to the DJIA decline than China's 9 percent correction. The DJIA hadn't seen a correction of more than 10 percent since 2003 it was oversold and due for a correction. Apprehension about the housing market and the sub-prime lenders began to surface. Goldman Sachs (GS) fell 6.7% that day. All of these concerns as well as the computer systems on Wall Street not being able to meet the demands of the volume of trading, coupled with the market correction in China all contributed to the US market correction last week.

So if this is merely a correction that was due, is it over? Is this the time to start investing again? Technically, not yet. A textbook correction would be the market pulling back at least 10%. It may take several more small pull-backs over the next couple of weeks before the market stabilizes again.

References

Ahmed, A. 2007. China market plunges, Dow follows. Now what? Chicago Tribune.