When discussing efficient markets, the one thing that we know is true is that prices will adjust quickly to new information. Markets may make mistakes but they will occur quickly. There an be under and over-reaction but there is still reaction to new information.
This immediate reaction is one of the reasons that policy-makers are often so careful about what they say and do. A wrong move and the markets will send a signal immediately. That kind of feedback is not always what policy-makers want to hear and the reaction may have follow-through. The information accumulated will have an impact on longer-term prices. The markets are sending signals to China policy-makers and it is saying that there are issues with current policies.
- Circuit breakers - First in and then thrown out. Investor market reaction is further exiting from stocks on this uncertainty. Circuit breakers are supposed to give investors time to assess market conditions, but that does not mean investors will be happy after the assessment is made. A large fear with circuit breakers is the potential for them to be absorption barriers. As prices get close to the circuit breaker levels, there is a pull to the barrier as investors try to beat the crowd before the market closes. The barrier becomes self-fulfilling.
- Restricted sale by shareholders - Added in the summer with an end date in January 2016. Now the rules have been changed to continue the policy. There is no certainty of market structure for large investors.
- Communications - No active open discussion on the market and regulatory environment. This causes market fear and uncertainty. Policy-makers are afraid of miscommunication but the lack of information sends a signal.
- Currency issues - The devaluation issue is real with the yuan declining in value against the dollar, but on a trade-weighted basis the yuan is up in value. This is a dollar issue with a transition in this market which is not clear to most investors
- Foreign reserves - Foreign reserves have further declined which suggests that they are being used to defend the yuan from a faster fall. Capital outflows are a problem given the above issues and the same concerns that investors have about all EM countries. Again, the signal has been that tighter controls may be in order.