Drop In China’s Shanghai Index Now Equal To That Of Crash of 1929

Amidst the hubbub of the New York Stock Exchange technical outage, it’s easy to neglect the fundamental problems afflicting the world’s economy.

Because the situation is so complex as well as being dire, we’ll attempt to sketch out what’s happening on the mainland of China, especially regarding the Shanghai composite. Today’s headline tells the tale. (However, it should be noted that elsewhere on the mainland, the CSI 300 index and the Shenzhen Composite ended 6.7% and 2.5% lower today respectively after touching multi-month lows. The Hang Seng index in Hong Kong was not spared the bloodbath, ending nearly 6% lower after having plunged as much as 8 percent.)

China is in a classic and very extreme speculative bubble that has been popped. Close to $5 trillion in value has been lost since June 18th.

"For the Hang Seng, there is a contagion impact as many of the Chinese investors who went into A-shares also bought into the H-share market and by association, Hong Kong will rise and fall according to the fortunes of China," Wong Sui Jau, general manager at Fundsupermart.com, told CNBC's "Street Signs Asia." "However, while it is affected by the volatility, the downside should be a lot less than China’s because the valuations of H-shares remain much lower than A-shares."

The rumor is that the central government is buying into big bank and oil/energy stocks in hopes of stanching the bleeding.

The problem China faces now is the “sell-what-you-can” syndrome. Those who have been shut out of selling equities that have been suspended on the Shanghai exchanges need cash or are in panic mode. So, other “good” stocks that they own are hitting the market, driving the price of such good stocks down as well. Of course, this adds to the general aura of instability and invites more panic selling.

Because the world is now so interconnected economically and electronically, this contagion is spreading to U.S. markets, and to Europe, which we know has its hands full with Greece. Chinese investors, especially institutions, are selling U.S.-listed stocks to get their hands on cash to cover bets they made on homeland stocks.

Before we move on to Europe, let’s describe one more aspect afoot in the Chinese markets – anger. Anger often follows close on fear and that is what is happening. That anger can create even more momentum selling. And it will undercut the air of invincibility that the Chinese government has cloaked itself in since the rise of the country’s economy in the last ten years.

In Europe, the main indices were up, an indication of faith in the continent’s basic economic strength. Banks, insurance companies and other financial providers led the charge while auto and equipment sectors fell back. Regardless of what might happen in Greece, equities in Europe seem to be sloughing off the crisis for the moment.

The euro gained strength unexpectedly against the dollar, indicating not so much a return to devotion to the euro zone’s currency but rather demonstrating it was oversold in the last few days.

U.S. markets were down across the board on both overseas fears and liquidity issues, which we discussed at some length in yesterday’s fundamentals email. How the NYSE will play out after it resumes trading (around 3PM in New York) will give a better snapshot of the complexion of the day. At 4PM, the Dow is pretty much where it left of at 11:32Am when the “glitch” began.

Gold has also been oversold, although you’d never know it from the selling done through regular trading. Today pricing is about the weaker dollar, which is accounting for all of the rise in the yellow precious metal.

Wishing you as always, good trading,