China's stock markets, its currency and the state of its economy came into sharp focus this month, with a lot of talk about volatility in the stock market and the moves in its currency.

Stock markets this Monday, fell sharply all around the world, with China's Shanghai Composite leading the way, falling more than 8 percent and erasing all of the gains it had made early this year.

On what was called China's "Black Monday", US stocks ended a volatile day with the S&P 500 and Nasdaq Composite Indexes sliding into correction territory, whilst stocks in Europe plunged as well with the main indexes down by 4 percent or more.

However, whilst Europe's stock markets were on track to enjoy their greatest surge since 2011, just a day after suffering their biggest loss in 4 years, equities in China continued their wild swings on Tuesday, with shares falling by another 7.6 percent in Shanghai.

Justin Stewart, co-founder of Seven Investment Management [Provided to China Daily]

"There are all the usual arguments about the economy slowing and valuations, but the real reason for such a turnaround is sentiment. The sentiment of confidence just evaporated," says Justin Stewart, co-founder of Seven Investment Management, a London-based financial company that has over £9 billion assets under management.

"There was no new news, no new key economic data, but the attitude changed. The old line always used to be was whether the glass was half full or half empty - for many frightened investors, they felt that the glass had cracked," Stewart adds.

Gillem Tulloch, founder of GMT Research, a Hong Kong based independent research company, says "The implosion of China's stock markets is likely to lead to negative sentiment globally. However, there are some benefits in developed economies from a slowing China. High end exports to China will be weak but lower commodity and energy prices are a wealth transfer to consumers."

As companies, products and commodities are nowadays interrelated, the global stock falls on Monday was not a coincidence, according to some asset manager.

"Initially all will fall out of a fear about what was happening. Then you move to a secondary stage when markets separate out the key factors effecting separate markets, sectors and companies. For example, a fear of Chinese slowdown affects commodity price which in turn affects mining companies which effects the UK FTSE 100, which affects UK pension holders."

Robin Geffen, CEO at Neptune Investment Management [Provided to China Daily]

Compared with most US and European equity markets that are institution-led, the Chinese stock market is mainly driven by retail investors, which is more volatile.

"Retail investors are far more skittish and think generally on a shorter time horizon than say a pension fund, whose investing scope would cover several decades. So what you see in the other markets is an initial reaction to the Chinese market falls, but then a steadying as institutions evaluate the longer term impact which they see as less of an effect on a decade long scale," Stewart explains.

He continues by saying that August is still a holiday period and therefore volumes are lower, thus any volatility is emphasised during such periods.

Thais Batista, Senior Research Strategist at Arbuthnot Latham & Co, a private bank in London, echoes Davis's view and believes that the lack of liquidity in the market is the trigger for the stocks drop in China early this week.

"There was a sequence of events that preceded the last episode but we believe the stronger factor is the lack of government support this time around. Since regulation has become stricter and market participants were reduced, decreasing liquidity has been a constant worry and 'flash crashes' can become more recurrent, especially in months like August," Batista says.

"Indeed the investor base can be more or less sentiment driven, impacting on markets volatility. That said, the US and European markets also have their share of 'fast money' – high frequency trading and all sorts of systematic trading, mainly driven by algorithms can behave on a similar fashion, chasing momentum. This is topped up by institutional investors facing stop losses and triggering more selling, which can magnify market moves."

However, some analyst says investors in China should be wise about telling the difference between real issues and the noise.

"We should remember that the stock market is still a very small part of the Chinese economy relative to other nations. The falls in China's A-share market that dominate the front pages are neither hugely reflective of economic reality, nor reflexive upon it," says Robin Geffen, CEO at Neptune Investment Management, a UK-based fund management company.

"As such, the 'real world' effects of these moves should be as limited on the way down now as they were on the way up recently. What is occurring now is a natural correction from an extremely overvalued and over-leveraged condition, precipitated by a large increase in equity supply," Geffen continues.

He points out that whilst the falls in the domestic market have been great in absolute terms, they are proportional to the gains experienced until April, adding "Over one year the Shanghai Composite Index is still up almost 45%, even after Monday's sharp fall."

In another bid to maintain momentum in the economy, the Chinese central bank devalued the currency, the yuan, which raised the concerns that the economy in China could be in worse shape than previously anticipated.

Geffen disagrees with the concerns, saying "The moves in the currency have also been largely misunderstood. China has not depreciated its currency per se, but rather moved to set a rate more influenced by the market and set against a basket of currencies rather than just the US dollar."

He believes this is about loosening domestic monetary policy conditions which have been de facto tightened by capital outflows, and moves to make key reference rates in China more market-driven.

"In China, we find an economy with real challenges but with a unique ability to meet those challenges in the form of the breadth of policy tools at its disposal, as witnessed by Beijing cutting interest rates by 0.25 percentage points on Tuesday," says Geffen.

Notwithstanding, some analyst says that the Chinese government intervention in the stock markets looks lustreless. China's stock markets had enjoyed a momentary rally, more than doubling in the year to mid- June, but have plummeted since then despite government's supportive policies.

"Experienced investors would not be surprised at the failure of government intervention as we have seen too many examples where politicians get this sort of action wrong. Another example was the UK government selling its gold at the bottom of the market in 1999," says Stewart at Seven Investment Management.

"Investors should want the government to not interfere and let the market find its real value level. Let the government get back to trying to run the economy. Stock markets reflect part of the economy, but they are not running the economy," Stewart adds.

Contact writer at: wangmingjie@mail.chinadailyuk.com