China’s stock market drop

China’s stock market has fallen by over 30% in the past 3 weeks. Due to the fall, 28 planned IPO’s have been placed on hold. The Central Bank and state-backed finance companies are intervening to reverse the decline.

The Chinese stock market’s performance over the last 3 weeks needs to be placed in perspective. Although there has been a 30% decline, this follows an over 80% run up in the last year. So far, the last 3 weeks look more like a correction than a fundamental market shift.

The reason why I decided to write about this is because many US tech sector investors have welcomed the drop in China’s stock market, indicating that it may foreshadow a similar correction in the price of US tech stocks. I don’t agree.

First, US tech companies are overvalued in the private markets, not in the public markets. Private markets where valuations are often set by the highest bidder behave very differently than public markets where valuations reflect a balance between supply and demand. While a decline in public markets may cause investors to lower their private market bids, it could also have the reverse effect. More investors may begin to look to the private markets for pockets of opportunity and this may increase valuations. The net effect, if there is one, is unclear.

Second, I would be very surprised to see China’s stock market performance emerge as a leading indicator for the valuation of US tech companies. Despite the tremendous success of companies like Alibaba, Tencent, and Baidu in China, the US remains the leader of the global technology sector. Any decline in the valuations of US tech companies, and hence tech companies globally, is very likely to begin with a fundamental shift originating from the US tech sector.